Guanxi and Business [3 ed.] 9789811210556, 9811210551

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ASIA-PACIFIC  BUSINESS  SERIES

(ISSN: 1793-3137)

Series Editor Leo-Paul Dana Professor of International Entrepreneurship Groupe Sup de Co Montpellier Business School, France Published Vol. 10 Guanxi and Business (Third Edition) by Yadong Luo Vol. 9

Asian Models of Entrepreneurship: From the Indian Union and Nepal to the Japanese Archipelago: Context, Policy and Practice (Second Edition) by Leo-Paul Dana

Vol. 8

Catalyst for Change: Chinese Business in Asia edited by Thomas Menkhoff, Hans-Dieter Evers, Chay Yue Wah & Hoon Chang Yau

Vol. 7

From Adam Smith to Michael Porter: Evolution of Competitiveness Theory (Extended Edition) by Dong-Sung Cho & Hwy-Chang Moon

Vol. 6

Islamic Banking and Finance in South-East Asia: Its Development and Future (Third Edition) by Angelo M. Venardos

Vol. 5

Guanxi and Business (Second Edition) by Yadong Luo

Vol. 4

Asian Models of Entrepreneurship — From the Indian Union and the Kingdom of Nepal to the Japanese Archipelago: Context, Policy and Practice by Leo-Paul Dana

Vol. 3

Islamic Banking and Finance in South-East Asia: Its Development and Future (Second Edition) by Angelo M. Venardos

Vol. 2

From Adam Smith to Michael Porter: Evolution of Competitiveness Theory by Dong-Sung Cho & Hewy-Chang Moon

Vol. 1

Guanxi and Business by Yadong Luo

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Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

Library of Congress Cataloging-in-Publication Data Names: Luo, Yadong, author. Title: Guanxi and business / Yadong Luo, University of Miami, USA. Description: 3rd Edition. | USA : World Scientific, 2020. | Series: Asia-pacific business series, 1793-3137 ; Vol. 10 | Revised edition of the author’s Guanxi and business, 2007. | Includes bibliographical references and index. Identifiers: LCCN 2019053426 | ISBN 9789811210549 (hardcover) | ISBN 9789811210556 (ebook) Subjects: LCSH: Industrial sociology--China. | Corporate culture--China. | Interpersonal relations- China. | Business enterprises--Corrupt practices--China. | Business networks--China. Classification: LCC HD6957.C6 L86 2020 | DDC 306.30951--dc23 LC record available at https://lccn.loc.gov/2019053426

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

Copyright © 2020 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher.

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For any available supplementary material, please visit https://www.worldscientific.com/worldscibooks/10.1142/11558#t=suppl Desk Editors: Balasubramanian/Lixi Dong Typeset by Stallion Press Email: [email protected] Printed in Singapore

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b3718   Guanxi and Business

PREFACE

Interpersonal relationship (guanxi) is one of the major dynamics of Chinese society. Guanxi has been a pervasive part of the Chinese business world for the last few centuries. It binds literally millions of Chinese firms into a social and business web. It is widely recognized that guanxi is a key business determinant of a firm’s performance, especially its market growth. Any business in this society, including both local firms and foreign investors and marketers, inevitably faces guanxi dynamics. In China’s new, fast-paced business environment, guanxi has become more entrenched than ever, heavily influencing Chinese political landscapes, social behavior, and business practice. Despite the current academic and practical interest in guanxi, there is no book-length treatment systematically and vigorously exploring the concept and practice of guanxi from the business perspective. This book addresses this lacuna by exploring various social, economic, cultural, and business issues relating to this complex concept and practice. As perhaps the first systematic effort along this line, this book, I hope, can serve as a conceptual, theoretical, and practical foundation upon which future studies may build so that our understanding of guanxi will no longer be fuzzy. This book is written not merely for academics but also for executives and business students who have an interest in doing business in China and beyond. It is intended to provide important managerial lessons and insightful practical guidance for them. Each chapter attaches several minicases illuminating how business people or companies develop and utilize guanxi to nourish economic activities. These minicases, except those directly adapted from public sources, are prepared by myself based on publicly available information solely for the purpose of class discussion.

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vi   Preface

The concept of guanxi is extremely nebulous and cross-disciplinary. Chapter 1 provides a definition of guanxi and other relevant concepts and delineates major principles underlying guanxi dynamics. It illuminates the social philosophy behind guanxi cultivation, utilization, and maintenance and outlines the importance of guanxi to social life. The relationships between guanxi, gifts, and bribes are also articulated. The expected importance of guanxi in the future and theoretical directions for future research are highlighted. Legitimate, healthy guanxi is a valuable asset for its possessor and aids in gaining economic rent, although it does not necessarily add value to the social welfare of the nation. Chapter 2 offers the economic rationale of guanxi and explains the difference between Chinese guanxi and Western networking. It also elaborates on guanxi as a necessity for achieving a competitive edge in the Chinese market. Managerial implications of guanxi are also illustrated. Guanxi network affects managers’ strategic choice and hence impacts the performance of the firms they lead. Guanxi has a direct impact on the market expansion and sales growth of Chinese firms by affecting resource sharing and social, economic, and political contexts in inter-firm transactions. Chapter 3 discusses guanxi network in relation to firm performance. It illuminates the influence of two forms of guanxi — with other businesses and with government officials — on two major aspects of performance, namely market growth and financial return. Although guanxi is embedded in almost every part of social life in China, companies demonstrate different needs and capacity toward guanxi cultivation. Chinese firms develop guanxi as a strategic mechanism to overcome competitive and resource disadvantages by cooperating and exchanging favors with government authorities and other stakeholders. Chapter 4 develops an integrative framework about guanxi development according to institutional, strategic, and organizational factors. It outlines guanxi at the organizational level, i.e., cross-organizational connections among managers. It articulates the influence of organizational dynamics on guanxi utilization and explains how firms with heterogeneously institutional, strategic, and organizational attributes use guanxi differently. The ultimate realization of guanxi potentials depends upon the application and operation of several business variables in which guanxi is

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Preface   vii

embedded since business activities are the breeding grounds where guanxi can play its role. Chapter 5 illustrates what guanxi-embedded business strategy variables are. This chapter also proposes and tests the influence of guanxi-based business determinants on firm operations. Foreign businesses can gain an edge over their competitors in the Chinese market by building and maintaining their own guanxi network in the country where guanxi often constitutes an effective and efficient marketing tool. Chapter 6 introduces strategic and operational traits of foreign direct investment (FDI) in China in recent years. It is followed by the discussion of how guanxi is important to foreign businesses and how foreign business attributes may affect guanxi cultivation. This chapter offers some managerial lessons to foreign companies. The “red envelope” culture is now popular and pervasive in China and beyond, a situation which calls for a distinction between guanxi and corruption. Chapter 7 addresses several critical issues pertaining to business implications of corruption. It defines the concept of corruption, explains the differences between guanxi and corruption, and describes corrupt activities, types, and reasons. This chapter also presents economic rationalities and business implications of corruption. I argue that, at the organizational level, corruption is an evolutionary hazard, strategic impediment, competitive disadvantage, and organizational deficiency. In a demoralized society, guanxi and corruption are increasingly intertwined. This chapter discusses this issue and explains the relationships among guanxi, corruption, and governance. This chapter ends with the discussion on how to build up an effective organizational architecture to resist corruption. Knowing how to construct, maintain, and reinforce legal, ethical, and healthy guanxi relations is imperative for any business in China. This knowledge has a favorable impact on both the effectiveness and efficiency of operations. Chapter 8 aims to provide practical guidelines to companies operating in China with respect to properly cultivating guanxi connections. This chapter lists eight suggestions: (1) constructing own network; (2) utilizing intermediaries; (3) searching for the right people; (4) transforming individual guanxi into organizations; (5) hiring locals and dispatching ethnic Chinese; (6) monitoring guanxi within an organization; (7) maintaining guanxi relations; and (8) improving credibility.

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Guanxi is really dynamic that its practices have been constantly changing and its normative and cognitive legitimacy is shifting as the social and economic structures in the society are drastically transforming. For this reason, this third edition of the book has added numerous new and emergent issues such as moral degradation and guanxi, qualitative and quantitative review of guanxi studies, and guanxi between organizations. Also for this reason, this book is only a primitive piece, but I do hope that readers will share my enthusiasm for the rich subject of guanxi. Yadong Luo University of Miami

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ABOUT THE AUTHOR

Dr. Yadong Luo is the Emery Findlay Distinguished Chair and Professor of Management at the University of Miami. He is currently Senior Editor of Journal of International Business Studies and Fellow of Academy of International Business (AIB) and Academy of Management (AoM). His research, teaching, and consulting interests include global business strategy, global corporate governance, international competition and cooperation, cross-cultural management, and business strategy in emerging markets. He has published nearly 200 journal articles and over a dozen original books. He is the recipient of dozens of research, teaching, and education awards for his long contributions to international management research and education.

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b2530   International Strategic Relations and China’s National Security: World at the Crossroads

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CONTENTS

Prefacev About the Authorix 1 Definition, Principles, and Philosophy of Guanxi1 1.1 Concepts 1 Definition1 Basis for Guanxi Establishment 4 Modes7 1.2 Principles 10 1.3 Philosophy 12 1.4 Guanxi in Social Life 20 1.5 Gifts, Bribes, and Guanxi26 1.6 Importance in the Future 31 1.7 Theoretical Directions 33 1.8 Future Research Agenda 36 1.9 Practical Examples 37 Minicase 1: Guanxi is His Middle Name 37 Minicase 2: A Smuggler with Guanxi39 Minicase 3: American Regulators Investigate JPMorgan Chase’s Hiring in China  41 2 Economic Sociology of Guanxi 43 2.1 Economic Rationale of Guanxi43 Social Capital 43 Economic Necessity 45 Economic Idiom 51 xi

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2.2 2.3 2.4 2.5

Guanxi versus Western Networks 52 Guanxi as a Critical Capability 54 Business Implications 59 The Use of Guanxi by Overseas Chinese Businesses 63 Economic Perspectives 64 Cultural Perspective 68 2.6 Practical Examples 71 Minicase 1: Guanxi: The First Step in Any China Venture 71 Minicase 2: Business Connections by Big Six Accounting Firms 73 Minicase 3: Will Technology and Globalization Undermine Old Networks like Guanxi?76 3 Guanxi and Business Performance 3.1 Conceptual Background 3.2 Guanxi and Firm Performance Guanxi with Other Businesses Guanxi with Government Officials Market versus Financial Performance Necessary versus Sufficient Condition Empirical Evidence 3.3 Meta-Analytical Review of Guanxi and its Value Literature Search Meta-Analytic Techniques Meta-Review Findings Multidimensional Guanxi and its multiform value Internal and external contingencies Evolutionary property Methodological moderators 3.4 Managerial Implications 3.5 Practical Examples Minicase 1: Chase Capital Uses Guanxi to Expand its Asian Business Minicase 2: Valuing Connections for Hong Kong’s Red Chips Minicase 3: Alibaba Runs into a Regulatory Ruckus

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4 Organizational Dynamics and Guanxi 111 4.1 Guanxi as an Interorganizational Network 111 4.2 Organizational Dynamics and Guanxi115 Institutional Factors 117 Ownership structure 117 Location118 Strategic Factor 119 Strategic orientation 119 Organizational Factors 121 Organizational size 121 Resources123 Length of operation 124 4.3 Empirical Evidence 127 4.4 Practical Examples 129 Minicase 1: Does Guanxi Matter in KFC? 129 Operations in China? 130 Minicase 2: Why is Shanghai Volkswagen Successful? 130 Minicase 3: Caterpillar Tracks a Wayward China Path 134 5 Guanxi-Based Business Strategies 5.1 Guanxi-Based Business Strategies 5.2 Impact of Guanxi-Based Business Strategies 5.3 Managerial Implications 5.4. Guanxi between Organizations 5.5 Practical Examples Minicase 1: Selling in China Minicase 2: Charoen Pokphand in China Minicase 3: Panda Diplomacy in Action

137 137 140 143 145 149 149 151 153

6 Foreign Businesses and Guanxi 157 6.1 Foreign Businesses in China 157 Shifting Environmental Conditions 159 New Competitive Landscape 160 Shift from scant competition to strong competition 160 Shift from niche competition to massive competition 161

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Shift from single-market conception to   multi-market competition 163 Shift from structural similarity to structural multiplicity 164 New Regulatory Landscape 165 Shift from entrance restriction to operational intervention 165 Shift from overt control to covert constraint 166 Shift from separation from to convergence with   domestic policies 168 Shift from regulatory rigidity to regulatory elasticity 169 Shifting Dominant Strategies 171 Shift from parent integration to national integration 172 Shift from production relocation to value chain   localization175 Shift from competence transfer to competence building 177 Shift from competition to coopetition with business   community181 Shift from repetition to adaptive diversification 184 Shift from alliance building to alliance restructuring 186 6.2 Guanxi and Foreign Businesses 188 Partner Effect 188 Origin Effect 189 Length Effect 189 Size Effect 190 Empirical Evidence 191 6.3 Implications and Examples 192 Minicase 1: H  ewlett-Packard’s Initiatives to Build up Guanxi192 Minicase 2: Boeing in China 197 Minicase 3: Foreign Firms are Still Welcome to and in China 200 7 Guanxi, Corruption, and Governance 203 7.1 Nature of Corruption 203 Definition203 Differences between Corruption and Guanxi207 7.2 Corruption in China 210 Current Situation 210 Types and Reasons 214

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7.3 Moral Degradation 219 7.4 Intertwineability between Guanxi and Corruption 222 7.5 Economics of Corruption 225 7.6 Business Implications of Corruption 232 Corruption as an Evolutionary Hazard 232 Corruption as a Strategic Impediment 234 Corruption as a Competitive Disadvantage 236 Corruption as an Organizational Deficiency 236 7.7 Governance and Guanxi238 Corporate Governance in China 238 Guanxi and Governance 242 7.8 Governance and Corruption 245 7.9 Taxonomy of Corruption 247 7.10 Corruption and Organizational Environment 251 Corruption and Task Environments 252 Corruption and Institutional Environments 255 7.11 Corruption and Organizational Behavior 258 System Malfeasance 259 Procedural Malfeasance 260 Categorical Malfeasance 261 Structural Malfeasance 262 7.12 Corruption and Organizational Architecture 263 Corporate Culture 264 Organizational Structure 265 Compliance System 267 Conduct code 267 Compliance program 270 7.13 Practical Examples 276 Minicase 1: Corruption in Yuxi Cigarette 276 Minicase 2: Rough Justice 282 Minicase 3: Bitter Pill: GlaxoSmithKline in China 285 8 Practical Guidelines to Guanxi Cultivation 8.1 Constructing Your Own Guanxi Network 8.2 Utilizing Intermediaries 8.3 Searching for the Right People

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8.4 Implanting Individual Guanxi into Organizations 295 8.5 Hiring Locals and Dispatching Ethnic Chinese 295 8.6 Monitoring Guanxi within an Organization 297 8.7 Maintaining Guanxi Relations 298 8.8 Improving Credibility 299 8.9 Practical Examples 301 Minicase 1: GM in Shanghai 301 Minicase 2: Solving Staffing Problems 305 Minicase 3: Joint Venture Mode and Guanxi308 Appendices 1  Summary of Anti-Corruption and Anti-Bribery Laws and Rules in China

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2  Summary of Anti-Corruption and Anti-Bribery Laws and Rules in the United States

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3  Transnational Cooperation in Combating Corruption and Bribery

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4  OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions

343

Bibliography 353 Index369

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1 DEFINITION, PRINCIPLES, AND PHILOSOPHY OF GUANXI

Interpersonal relationship (guanxi) is one of the major dynamics of Chinese society. Guanxi has been a pervasive part of the Chinese business world for the last few centuries. Any business in this society inevitably faces guanxi dynamics. This chapter begins with a definition of guanxi and other relevant concepts followed by major principles underlying guanxi dynamics. The third section illuminates the social philosophy behind guanxi cultivation, utilization, and maintenance. The fourth section outlines the importance of guanxi to social life. The relationships between guanxi, gifts, and bribes are articulated next. The expected importance of guanxi in the future and theoretical directions for future research are highlighted at the end.

1.1 CONCEPTS Definition Guanxi is one of the major dynamics in Chinese society. Guanxi has been a pervasive part of the Chinese business world for the last few centuries. It binds literally millions of Chinese firms into a social and business web. It is widely recognized that guanxi is a key business determinant of firm performance. It is the lifeblood of both the macro-economy and micro-business conduct. Any business in this society, including both local firms and foreign investors and marketers, inevitably faces guanxi dynamics. No company can go far unless it has extensive guanxi networks in this setting. 1

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2   Guanxi and Business

The Chinese word “guanxi” refers to the concept of drawing on connections in order to secure favors in personal relations. It forms an intricate, pervasive relational network which the Chinese cultivate energetically, subtly, and imaginatively. It contains implicit mutual obligations, assurances, and understanding and governs Chinese attitudes toward longterm social and business relationships. Broadly, guanxi means interpersonal linkages with the implication of continued exchange of favors. Guanxi is therefore more than a friendship or simple interpersonal relationship; it includes reciprocal obligations to respond to requests for assistance. Unlike inter-firm networking in the West, however, this reciprocity is implicit, without time specifications, not necessarily equivalent, and only socially binding. Interpersonal relations are certainly not peculiar to the Chinese society. They exist to some extent in every human society. What is special about guanxi is the fact that it is ubiquitous and plays a fundamental role in daily life. The Chinese have turned guanxi into a carefully calculated science. Constructing and maintaining guanxi is a common preoccupation for entrepreneurs, managers, officials, and even college students. Although used in speech since a century ago, guanxi does not appear in either of the classic Chinese dictionaries, Ci Yuan (“Source of Words,” published in 1915) or Ci Hai (“Word Sea,” published in 1936). The word consists of two characters, guan and xi Guan originally meant a door; its extended meaning is “to close up.” Thinking metaphorically, inside the door you may be “one of us” but outside the door your existence is barely recognized. Today guan is often used to mean a pass in various sorts of economic lives, from social activities to organizational names (e.g., hai guan means “customs”). In addition, guan can refer to “doing someone a favor.” For instance, guan xin means “showing solicitude for,” guan huai means “showing loving care for,” and guan zhao means “looking after” or “support.” Xi means to tie up and extend relationships, such as kinship (shi xi ) and directly related members of one’s family (zhi xi qin shu ). It implies formalization and hierarchy. While the word primarily applies to individuals, the concept can also be used similarly with organizations (e.g., xi means “department”). Xi can also be used to refer to maintaining longterm relationships. For instance, wei xi means “to maintain.”

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Definition, Principles, and Philosophy of Guanxi   3

Guanxiology is a cross-disciplinary, integrative field researching the formation, process, and outcome of guanxi connections. It has five features. First, guanxiology is a multi-level field. At the macro-level (context), it involves family, community, and society. At the semi-macro level (firm), it relates to managerial policy, business practices, marketing mix, organizational behavior, human resource administration, corporate culture, and business strategy. At the micro-level (individual), it links to interpersonal relations, incentive structures, social status, and family connections. Second, guanxiology is cross-disciplinary. It has roots in sociology, economics, history, psychology, politics, and business. None of these disciplines is more important than the others. Each explains different but partial aspects of the rationale and processes of guanxi formation, development, and consequences. Third, guanxiology is highly integrative. Although cross-disciplinary, guanxiology has a unique, independent core of interpersonal relationship. To understand this core thoroughly, one needs to integrate all the related fields with environmental dynamics. The objective of integration is not simply to pull relevant, complementary paradigms or notions together but rather to strengthen our complete understanding of guanxi. Fourth, guanxiology is extremely dynamic. This is mirrored not only in the process orientation of guanxi but also in the evolutionary nature of the field. Guanxiology assesses antecedent, concurrent, and consequent factors in the entire chain of guanxi cultivation. These antecedents, as well as related assumptions, may alter over time as contextual contingencies change. Therefore, guanxiology itself, though maintaining its core, continuously develops. Finally, guanxiology is practice oriented. Although guanxiology has its theoretical paradigms and conceptual principles, it hinges largely on practical dynamics. These dynamics shed light on how guanxi is constructed, maintained, and reinforced, hence enriching the development of guanxiology. Changes in the environmental contingencies affecting practice also influence the contributions and implications guanxiology makes to social welfare. Because of this, guanxiology is both a science and an art. Guanxiology is worth examining because of the popular gloss given to its semantics, a gloss that brings out its satiric significance. It elevates the

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4   Guanxi and Business

art of cultivating personal relationships into a full-fledged scholarly branch of knowledge equally valid and just as necessary as any other academic specialization (Yang, 1994). A related concept is guanxi xue , which literally means guanxiology. In practice, however, the Chinese use guanxi xue to express their concern with the tactics of guanxi construction and cultivation. Guanxi xue refers to the practical strategies that best ensure personal relationship building, utilization, and development. It implies skill, subtlety, and cunning, as conveyed by the English word “artfulness.” Guanxi xue involves the exchange of favors and gifts, the cultivation of personal relationships and networks of mutual dependence, and the manufacturing of obligation and indebtedness. What informs these practices and their native descriptions is the conception of the primacy and binding power of personal relationships and their importance in meeting the needs and desires of everyday life. A corpus of assumptions and practices has been woven into a vociferous, self-conscious discourse. This discourse treats these personal exchange practices as something new, a social phenomenon that has gained strength in recent years (Yang, 1994). Guanxi xue places an emphasis on the binding power and emotional and ethical qualities of personal relationships. It appears in economic transactions; political and social relationships; literature, newspapers, academic journals, theater, and film; and in both popular and official discourses. Compared with other social practices, there also seems to be a greater cultural elaboration of vocabulary, jokes, proverbs, and etiquette surrounding guanxi xue. In short, it is a ubiquitous theme in Chinese society.

Basis for Guanxi Establishment The establishment of guanxi is dependent on the availability of a guanxi base — defined as a commonality of shared identification among two or more people. A guanxi base, whether ascriptive (e.g., based on kinship) or achieved through shared experience, facilitates the development of a guanxi relation without predetermining it. The relevance of any one type of guanxi base is different in different situations. For example, having a similar dialect

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Definition, Principles, and Philosophy of Guanxi   5

identity is important for inter-firm relations but less important than kinship in the ownership and control of a firm. Over time, along with significant changes in the environment, the importance of a given guanxi base can also vary. The importance of guanxi remains, however. Possible bases for guanxi are detailed as follows: 1. Locality or dialect. For example, during the early stages of emigration to Singapore, many immigrants from China arrived without their close kin. They would turn to people from their villages or districts in China for food, lodging, and work. They grouped together according to locality of origin and spoken dialect. The latter criterion was more important as the dialects were mutually incomprehensible. This guanxi base was often institutionalized into mutual help associations organized along the locality/dialect criteria. The importance of this guanxi base may diminish over time as later generations become more economically independent and more actively interact with the larger society. 2. Fictive kinship. The Chinese also organized clans based on common surnames. People sharing the same surname were considered kinsmen and were believed to have descended from the same ancestor. 3. Kinship. One’s immediate kin may be categorized as either agnatic (related by blood, usually to the father’s line) or affinal (related by marriage). While affinal guanxi are theoretically less reliable than agnatic ones, an affinal guanxi base is often important in helping a businessman develop a dependable guanxi network. Marriage was once used to bind two families together or tie a capable employee to oneself. The kinship guanxi base is important in intra-organizational relations, specifically in terms of shared ownership and control of business among private organizations. While kinship as a guanxi base remains relevant, the development of mass production, small family size, monogamous marriages, and more economic opportunities have challenged the availability of this base for the management and control of Chinese enterprises. In Hong Kong, Singapore, and Taiwan, for example, a new strategy adopted by Chinese businesses is the bifurcation of ownership and management, where professional non-kin managers are hired to run the company but ownership and control remain within the family network.

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6   Guanxi and Business

4. Workplace. Colleagues share other bases of guanxi. Traditionally, colleagues were more often than not fellow villagers from the same dialect group or even distant relatives. Years of working together provided them with another basis for establishing or strengthening guanxi. Colleagues are important when one decides to start a new business. They are already familiar with one’s line of business, have some savings, and can usually be trusted after years of collaboration to be good business partners. Many private businesses in China today are formed by people who were former colleagues. 5. Trade associations or social clubs. Trade associations facilitate information gathering and opportunities for interaction through social dinners and activities. They provide opportunities to establish guanxi with potential buyers, suppliers, and financiers. In this sense, trade associations or social clubs can be viewed as a form of institutionalized guanxi. 6. Friendship. Friendship refers to relationships between people other than kin. These relationships are tinged with ganqing (affection or sentiment). Friendship is not, however, considered a true guanxi base. Rather, another basis for guanxi, such as being colleagues, seems to be a prerequisite for the establishment of friendship. Friendships are important because they strengthen more close-knit guanxi, which is crucial in business. Red tape and lengthy business procedures can be avoided if an element of friendship and corresponding credibility is present. Without ganqing, guanxi is more distant and less reliable. The chances of securing a favor depends, in part, on ganqing and the closeness of guanxi which it enables. In Chinese society, each person having such bases shares aspects of personal identification with others that are also important to them as individuals. They can assert identification with kin, hometown, school, workplace, sworn brotherhood, and so on. For example, two people with classmate guanxi identify with an educational experience important to both of them. For simplicity’s sake, guanxi bases are divided into blood bases and social bases. The former includes only one’s family members, relatives, and members of the same clan; the latter includes the bases which mainly arise from social interactions. Since the family is the basic building unit of Chinese society, family guanxi is the most important of all kinds of guanxi. Relationships with relatives are closer than with friends and other people. Family members are those a person depends on and trusts the most. This

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Definition, Principles, and Philosophy of Guanxi   7

is the reason why family businesses are the dominant form of corporate governance among the overseas Chinese. It should be noted that the existence of a basis for guanxi does not imply that such an alliance will develop. For example, a person may have many relatives, whom he has never met or is not personally close to. The existence of a base only paves the way for an opportunity to establish guanxi. Without a pre-existing guanxi base, it is more difficult to establish such business relationships. If a shared guanxi base cannot be located, one may have to rely on intermediaries who have guanxi bases in common with both oneself and one’s desired business contact. Personal recommendations are therefore also important. Guanxi is dynamic and certain social bases for guanxi can be transferred. Many foreign companies use this tactic to initiate guanxi in China. For example, cosmetics manufacturer Avon initially failed to convince the central government of the viability of its direct marketing method. Avon later obtained the assistance of David Li, the head of Hong Kong’s Bank of East Asia. Li was well known for his cordial guanxi with the Chinese government. He successfully introduced Avon to the Bureau of Light Industry in southern China. An arrangement was later worked out in which Li became a partner with Avon, with five percent equity, because of the services he rendered.

Modes To understand the importance of guanxi and how it operates, one must look to China’s Confucian legacy. According to Confucianism, an individual is fundamentally a social or relational being. Social order and stability depend on properly differentiated role relationships between particular individuals. The word lun was used in Confucian ideology to refer to a concept similar to guanxi. There are five such traditional relationships (wu-lun ): prince–subject, father–son, older brother–younger brother, husband–wife, and friend–friend. All are superior–subordinate relationships except friend to friend. Confucian relationships were therefore a classificatory paternalistic order which ranked from parents to the sovereign through the master and servant. These five relationships are the basis of Chinese social networks. Wu-lun is a highly formal cultural system, requiring each actor to perform his or her role in such a way that he or she says precisely what he or she is supposed to say and does not say what he or she is not supposed to

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say (Yang, 1994). In order to perform one’s role well, the actor usually has to hide his or her independent will. This is why Chinese have been said to be situation centered or situationally determined. Because of the heavy influence of Confucianism, Chinese often view themselves as interdependent with the surrounding social context. The self in relation to the other becomes the focus of individual experience. This view of an interdependent self is in sharp contrast to the Western view of an independent self. The latter sees each human being as an independent, selfcontained, and autonomous entity who (a) comprises a unique configuration of internal attributes (e.g., traits, abilities, motives, and values) and (b) behaves primarily as a consequence of these internal attributes. This divergent view of self has implications for a variety of basic psychological processes (e.g., cognition, emotion, and motivation) and may be one of the most fundamental differences between the East and the West in social relations. In a relation-centered world, social relations are accorded much greater significance. Relationships are often seen as ends in and of themselves rather than as a means for realizing various individual goals. As part of the emphasis on differentiated relationships, attention to others is highly selective and mostly characteristic of relationships with in-group members. Many observers of Chinese social relations (e.g., Butterfield, 1983) have noted that in comparison to the West, Chinese have a much stronger tendency to divide people into categories and treat them accordingly. This tendency of treating people differently depending on one’s relationship to them constitutes the basic reason why guanxi is of such importance in Chinese societies. Yang (1994) described three major categories of interpersonal relations in China: jia-ren (family members), shou-ren (familiar persons such as relatives outside the family, neighbors or people in the same village, friends, colleagues, or classmates), and sheng-ren (mere acquaintances or strangers). These three categories of relationship have completely different social and psychological meanings to the parties involved and are governed by different sets of interpersonal rules. The jia-ren (family) relationship is characterized by relatively permanent, stable, expressive relationships in which the welfare of the others is part of one’s duty. The general rule of exchange is that one must do his or her best to attend to the other’s needs with little or no expectation of return in the

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future. In traditional Chinese societies, primary loyalties cluster around the family, surrounded by circles of decreasingly potent identification with the lineage group and then the regional clan. One of the most distinctive features of Chinese society is this family orientation. The in-group favoritism based on kinship guanxi is due to strong family identification and role obligations. It is rendered largely without anticipation of reciprocity. The sheng-ren (stranger or mere acquaintance) category includes all those who are outside the family unit and with whom one has not established any meaningful relationship through past interactions. These could include members of one’s local community, fellow employees who work in the same (large) company, or business customers. Interactions with sheng-ren are superficial and temporary and are dominated by utilitarian concerns. The focus is on personal gain and loss. The defining characteristic of this relationship is instrumentality without affection, unlike the relationship with jia-ren, which involves primarily affection, or shou-ren, which has both an instrumental and an affect component. A shou-ren, by definition, is neither a jia-ren (member of the family) nor a sheng-ren (mere acquaintance or stranger) but rather someone with whom one has a friendship that may range from superficial to extremely intimate. A co-worker or a subordinate can fall into this category. The relationship with the shou-ren (friend) is a mixture of jia-ren and sheng-ren and takes both utilitarian and expressive forms. The principle of renqing (social obligation) that underlies most friendships suggests that favoritism is often followed by a strong expectation of reciprocity. Cultivating renqing is said to be a prerequisite to establishing or sustaining the relationship among friends. In summary, depending on the bases of guanxi, an interpersonal relationship can fall into any one of the three categories. Within each category, the relationship can vary in the degree of closeness or strength. For example, involvement with a co-worker who was also a college classmate implies a stronger relationship than with one who was not a classmate. To the traditional Chinese, guanxi was primarily meaningful for the jia-ren and shou-ren categories. However, as Chinese societies moved away from a traditional, agrarian life style to an industrialized, pluralistic one, individual freedom has risen and collective forces have ebbed. The potential for interpersonal

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relationships in the sheng-ren category has become increasingly important (Tsui and Farh, 1997).

1.2 PRINCIPLES There are several important principles underlying guanxi cultivation, utilization, and maintenance. First, guanxi is transferable. If A has guanxi with B and B is a friend of C, then B can introduce or recommend A to C or vice versa. Otherwise, contact between A and C is unlikely. For this reason, formal business correspondence usually will not receive a reply until direct personal contact has been established. The success of transferability depends on how much satisfaction B feels about his guanxi with both A and C. Transferability also means that guanxi is different from friendship. Affection is important but not a prerequisite for guanxi, whereas affection is necessary for friendship. Only strong guanxi relations contain affection and, hence, friendship. Weak guanxi partners, however, are not necessarily friends. Second, guanxi is reciprocal. A person who does not follow a rule of reciprocity by refusing to return favor for favor will lose face (mianzi ) and be seen as untrustworthy. Nevertheless, exchanges often favor the weaker partner. At the individual level, guanxi links two persons, often of unequal rank, in such a way that the weaker partner can call for special favors for which he does not have to reciprocate equally. This reciprocity explains another distinction between guanxi and friendship. Third, guanxi is intangible. It is established with an expectation of an unlimited exchange of favors. It is maintained over the long run by an unspoken commitment to others in the web. People who share a guanxi relationship are committed to one another by an invisible and unwritten code of reciprocity and equity. Disregarding this commitment can seriously damage one’s social reputation, leading to a humiliating loss of prestige or face. Fourth, guanxi is essentially utilitarian rather than emotional. Guanxi bonds two persons through the exchange of favors rather than through sentiment. This relationship does not have to involve friends, though that is

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preferred. Guanxi relations that are no longer profitable or based on mutual exchange are easily broken. Because of this principle, individually embedded guanxi can easily extend to organizationally embedded connections. Employees earn benefits such as bonuses, commissions, and promotions when they transfer personal guanxi to the organization. Organizations also benefit from each other’s guanxi exchanges. Returns are favored when the resources and skills of two parties are complementary and both parties strategically need each other. Fifth, guanxi is contextual. It involves interactive conduits between people. Cultivating guanxi is completely context specific. The giving of a gift (a carton of Marlboros to the boss) in one context (the boss and spouse have a baby) is an accepted part of the culture of gift-giving. In another context (you are up for a promotion), it might be seen as instrumental. In a third context (your shiftless brother-in-law needs a job), it might be considered a bribe. Because guanxi development is contextual, its construction and application is more an art than a science. Realizing the importance of guanxi and understanding its principles are easy; finding and implementing an appropriate approach to fulfilling guanxi relations is difficult. Sixth, guanxi is long-term oriented. Members of Confucian societies assume the interdependence of events, understanding all social interactions within the context of a long-term balance sheet. People in this context believe that duality and contradiction (yin and yang ) are inherent in all aspects of life. Every guanxi relationship is regarded as a kind of stock to be put away in times of abundance and plenty, but brought out in times of need. It is developed and reinforced through continuous, long-term association and interaction. By contrast, social transactions in the West are usually seen as isolated occurrences, with great emphasis placed on immediate gains from the interaction. Some guanxi relationships never end, but continue from generation to generation if continuously maintained. Lastly, guanxi is personal. Guanxi between organizations is initially established by and continues to build upon personal relationships. When the person who brought a guanxi connection leaves, the organization loses the guanxi as well. In other words, guanxi has no group connotation. This principle largely explains the difference between guanxi and interorganizational networking in Western countries. Although personal attachment

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may facilitate interpartner cooperation and mitigate inter-firm conflict, interpersonal relations are not a prerequisite for inter-firm networking in the West. Since the “iron rice bowl” was broken in the early 1980s, the application of guanxi at the organizational level has become increasingly pervasive and intensive in China. This is because an employee can be rewarded (e.g., by a commission or bonus) or promoted by an organization if he or she uses personal guanxi for organizational purposes (e.g., marketing, promotion, and sourcing). This trend has become more evident since 1985 as the number of township and village enterprises and privately owned businesses have grown, and state-owned firms have started to use the “contractual liability lever” in their management and reward systems. Paradoxically, even as an unabated opening of the Chinese economy has resulted in a convergence of Chinese management philosophies with modern Western and Japanese ones, the concept of guanxi has turned out to have powerful implications. A number of new terms associated with guanxi have been created, immediately permeating the society. “La guanxi ” (“pull” guanxi) means to get on the good side of someone and store social capital with him or her; it carries no negative overtones. “Gua guanxi ” (“work on” guanxi) means roughly the same thing, but has a more general, less intense feeling and usually has negative overtones. “Guanxi gou qiang ” (“guanxi made ruined”) means the relationship has gone bad. “Li shun guanxi ” (“straighten out” guanxi) means to put guanxi back into its proper order, often after a period of difficulty or awkwardness. “Guanxi wang ” (“guanxi net”) means the whole network of guanxi within which favors are exchanged and circulated. Finally, “guanxi hu ” (“guanxi family”) means a person, organization, even governmental department, which occupies a focal point in one’s special guanxi network.

1.3 PHILOSOPHY Guanxi are delicate fibers woven into every Chinese individual’s social life, and therefore, into many aspects of Chinese society. Although the cultivation of guanxi has become the focus of researcher attention only

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since the decentralization and privatization of the Chinese economy, its roots are deeply embedded in 2000 years of Chinese culture. Confucian social theory is concerned with the question of how to establish a harmonious secular order in a man-centered world. According to Confucianist philosophy, the individual is never an isolated, separate entity. All humans are social or interactive beings. Although guanxi was not found in the Confucian classics, the word lun was used. The concept of lun concerns the differentiation of individuals and the kinds of relationships to be established between individuals. Confucian social order is constructed upon the concept of lun. There are eight principles of moral behavior. They are zhong (loyalty), xiao (respect), ren (kindness), ai (love), xin (trust), yi (justice), he (harmony), and ping (peace). These principles are the foundation of Chinese human relations and networks. An actor in the network should obey these principles in order to maintain his or her face before society. Ever since Confucius codified the societal rules, values, and hierarchical structures of authority during the sixth century B.C., Chinese society has been functioning within clan‑like networks. Such networks can be viewed as concentric circles. Close family members are at the core and distant relatives, classmates, friends, and acquaintances are peripherally arranged in accordance to the distance of relationship and degree of trusts. A purposeful investment in time and energy is frequently made to maintain and extend such networks. When a situation arises where one’s business undertaking is beyond one’s individual capacity, the guanxi network is often mobilized to influence some key person’s decision making in order to achieve desirable results. As a social philosophy, Confucianism is concerned with the practical task of trying to establish a social hierarchy strong enough to harmonize a large and complex society of contentious human beings. One of Confucianism’s key tenets holds that all human relationships fall into two categories: “predetermined” and “voluntary.” In a predetermined relationship, behavioral expectations are dictated by one’s status within and responsibilities to a predetermined group, such as one’s family. Individual desires are heavily downplayed. But in many relationships that take place beyond the family, the individual plays an active role in determining the character and tone of the exchanges (Warner, 1986). These are “voluntary” relationships. The individual’s dual role — both as a passive follower of

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predetermined relationships and initiator of voluntary relationships — can make guanxi interactions very complicated. The Chinese people place great stock in the importance of mianzi (face). This is an individual’s public or social image gained by performing one or more specific social roles that are well recognized by others. Though highly abstract, the concept of face is treated by the Chinese as something that can be defined quantitatively. How much face an individual has depends partly on his or her guanxi network. The larger one’s guanxi network and the more powerful the people connected within it are, the more face one has. One needs to have a certain amount of face in order to cultivate new guanxi relationships. Mianzi also provides the leverage one needs to successfully expand and manipulate a guanxi network. Enjoying the prestige of not losing face and, at the same time, saving other people’s face are key components in the dynamics of guanxi. According to tradition, “losing face” socially is comparable to the physical mutilation of one’s eyes, nose, or mouth. Mianzi is therefore an intangible form of social currency and personal status, often determined by social position and material wealth. In a guanxi relationship, both parties must carefully observe certain unspoken rules of reciprocity and equity. Disregarding or violating these rules can seriously damage one’s reputation and lead to a humiliating loss of prestige. The loss of face associated with opportunistic behavior spreads quickly through the guanxi network due to its transferability. Opportunistic behavior with one exchange partner can be interpreted as opportunistic behavior by people within the entire network. Opportunistic behavior only becomes an attractive option when the expected payoff from such behavior outweighs the expected costs. In a guanxi network, the cost of opportunism is the potential loss of exchange opportunities with all members of the network. The larger and more richly connected the guanxi network, the greater the assurance that an individual exchange partner within the network will not risk the potential ostracism that could result from opportunistic behavior. The mere promise of network expansion provides increased assurance that one’s exchange partner will not act opportunistically. Guanxi thereby replaces the need for trust in an exchange relationship. Another related concept is renqing — unpaid obligations resulting from invoking a guanxi relationship. Renqing is a form of social capital that can

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provide leverage during interpersonal exchanges of favors. Developing renqing is both a precondition for the establishment of guanxi and a consequence of using it to one’s own advantage. While Chinese people weave networks of guanxi, they also weave webs of renqing obligations that must be repaid in the near future (Hwang, 1987). In essence, renqing provides the moral foundation for the reciprocity and equity that are implicit in all guanxi relationships. If you disregard the rule of equity while exchanging renqing favors, you may lose face, hurt your friend’s feelings, and jeopardize your guanxi network. Guanxi is embedded in renqing formulation as an endless flow of interpersonal exchanges and reciprocal commitments. The discourse of renqing articulates the moral and decorous character of social conduct. It implies the necessity for reciprocity, obligation, and indebtedness in human relations. What activates reciprocal relations and imbues these relationships with a sense of obligation and indebtedness are relational sentiments and ethics. The positive role of guanxi is determined by the degree of closeness between parties, which is further determined by ganqing (human feelings or affection). Ganqing is a measure of the emotional commitment of the parties involved. Generally, ganqing involves greater degrees of affection than renqing. Giving gifts to a government official is a matter of courtesy and observance of proper social form and etiquette. It can lead to the establishment of a good relationship, but not to ganqing. To demonstrate that one’s ganqing is sincere, one must live up to the guanxi obligations upon which one’s ganqing is based. Together, guanxi and ganqing create and maintain emotional connections between individual Chinese while defining the activities that constitute their mutual social identities. Hence, guanxi is often viewed as an essential element of Chinese socio-cultural behavior and an important dimension in the social structure of Chinese society. The value of ganqing and guanxi is not static, but changes over time. Both the occurrence of ganqing and the development of close guanxi hinge upon continued social interaction and mutual help. The type of guanxi base does not, however, appear to affect the development of close guanxi imbued with ganqing. The value of a trade association, for example, depends on mutual help rendered, good prices offered, provision of tips and other news, and credibility.

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Because ganqing determines the favorability and sustainability of guanxi, creating and maintaining ganqing is critical. To build up ganqing, sharing social activities such as drinking, working, or studying together is a prerequisite. Two persons may have a guanxi base, but not necessarily build guanxi relations. Whether or not a guanxi base (e.g., alumni of the same college) can be transformed into a guanxi relation depends upon ganqing. To strengthen guanxi, both parties must cultivate ganqing. Xinren (trust), another important element of guanxi, is closely associated with ganqing. The greater the ganqing between two people, the greater the xinren. The reason why guanxi between family or clan members is the strongest and most sustainable relationship is that Chinese generally do not trust people outside their families. Parties establishing guanxi based on voluntary, social factors must demonstrate positive feelings of empathy for each other in order to overcome this initial distrust. They will have to work actively to maintain the relationship by fully reciprocating favors received and help each other any time one of them is in particular need of assistance. This will build a personal connection and loyalty that can be relied upon. When two strangers want to do business, an intermediary is imperative. The intermediate agent acts as a catalyst by using his or her mutual friendship and xinren for each of the other two parties to bring them together. Since Western business relationships do not necessarily contain this personal element, Westerners tend to underestimate the time it takes for Chinese to assess the suitability of a close, personal, non-familial relationship. Trust is often considered the ability to rely on another because he or she is perceived as credible or competent. Trust between business persons entails expectations of reliability and competence in the delivery of expected outcomes. Trust is an especially important element of a sustained guanxi relationship because it limits the likelihood of opportunistic behavior in a business environment that lacks established rules of law or traditionally does not enforce laws strictly. When two parties trust that each will treat the other in a fair, reliable, and competent manner, then their continued transactions will be facilitated even in the absence of legal and contractual mechanisms for monitoring veracity. For example, a Chinese businessperson who develops a reputation for breaking promises to sell at a certain price will be forced to deal on a cash basis with suppliers. This suggests the importance of

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always being seen as trustworthy. In one study, 85 percent of managers whose companies were doing business in China reported that trust was an essential condition for guanxi and that guanxi could not exist without trust (Yeung and Tung, 1996). While Westerners attach value to systems trust, Chinese business practices emphasize personal trust. Systems trust, as in a financial institution, assume that the system is functioning correctly; trust is placed in the system, not specific individuals. Agencies which form part of the system function to generate trust, reduce reliance on people, and make personal guarantees dispensable. For instance, when two parties sign a written agreement, they are depending on the law to bind the contract. Although this does not imply that personal trust can be altogether dispensed with, the involvement of an external agency decreases the personal element of transactions and enhances objectivity. Therefore, systems trust is associated with professionalism and rationalism. In a modern context, the adoption of the more impersonal form of systems trust supposedly increases the legitimacy of transactions. Chinese managers view personal trust as more important than systems trust. Credibility refers to trust between individuals which bypasses a third agency. Risks are borne by the individuals and cannot be absorbed by an external agency. The contract between individuals is not bound by an external body. Although credibility is embedded in social relations and subject to social sanctions, its underlying principle grants those who apply it a sense of moral superiority over those who rely on systems trust because it is presumably based upon the honesty and integrity of individuals. Nevertheless, over time, there may be a gradual shift from personal trust (e.g., verbal agreements) to systems trust (e.g., written contracts) as China’s economy opens up and as the legal framework develops. The institution of personalism, once established, is resistant to change. Its persistence goes beyond functional necessity. Many young Chinese managers have already accepted Western standards of professionalism and the idea that systems trust is superior, as espoused by powerful MNCs. Trust is often placed only where there is sufficient control over the reliability of a system. This control must function independently of the personal motives of any one individual at any given time. This ensures that one does not need to personally know those who have the knowledge that one needs. Some Chinese firms have therefore begun to mimic certain structural features of foreign MNCs in recent years.

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Kexin (credibility) refers to the degree of a party’s trustworthiness. A high level of kexin boosts guanxi and its sustainability over the long run. A guanxi relationship with someone who has little kexin is unreliable, unpredictable, and unstable. In order to develop long-standing, solid guanxi, one has to assess the party’s kexin. This can be identified from his or her social reputation, educational background, previous examples of trustworthiness or opportunism, and solidity of guanxi with other people. Kexin does not depend on how many guanxi connections he or she has established (quantity), but rather how good the relationships are (quality). A party’s kexin can be gauged from whether he or she always keeps promises and whether he or she did his or her best to help guanxi partners when they badly needed help. People normally give high credit to those who are more concerned about their guanxi partners than themselves when their partners need help. A person willing to make a sacrifice on behalf of others repays debts no matter what difficulties he or she faces or returns favors no matter what the personal cost, and possesses utmost kexin. The principle of kexin is illustrated in the following incident: A Chinese deputy general manager of a Sino-foreign joint venture once urgently needed certain components in her factory. The components were in short supply but through her guanxi, she managed to obtain them from a friend in a factory in another city. Based on mutual trust, a cash-on-delivery price was agreed upon verbally and the components were sent to her factory. However, her factory was experiencing a cash flow problem when the components arrived. In order to uphold her credibility, she paid the bill out of her own savings — an amount roughly equal to her annual salary. She says that if she had not done so, the guanxi with her friend would have been tarnished.

As one manager noted: “Your capital is your kexin. They trust you, they will do business with you. This is especially so among the Chinese. Not much capital is needed to start a business. If you have credibility, that is enough. People will give you financial credit.” Guanxi and credibility fertilize each other. Chinese managers believe that interpersonal trust minimizes fraud to

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ensure certainty and order. They maintain that formal legal sanctions are unnecessary for inducing performance and all contingencies need not be stipulated contractually. With guanxi, these issues can be settled informally. When starting a new economic relationship, an established merchant can rely on his or her accumulated kexin. A newcomer, however, has to build his or her kexin from scratch. Initial establishment of kexin depends on the willingness of others to undertake risks with someone. This willingness is influenced by the pre-existence of shared guanxi bases. If there is neither pre-existing guanxi nor a shared guanxi base, the reluctance to undertake risk is high. Further, the time taken to build good kexin also depends on the quality of developed guanxi. If close guanxi ties are developed during a period of economic exchange, and the relationship is imbued with ganqing, the number of tests of one’s kexin can be reduced. Guanxi and kexin are causally linked, with the improvement in one increasing the quality of the other. Tiaohe (harmony) is another key value in the building and maintenance of guanxi. While business students in the United States are taught to confront their disagreements and openly discuss their negative feelings as a strategy for integrating people with different perspectives, the Chinese avoid aggressive confrontations and regard them as bad manners. Western culture often equates sincerity with the free expression of every positive or negative emotion while Chinese children are trained from birth that negative emotional displays are both unsociable and inconsequential in influencing outcomes. Personalities that vary between positive and negative emotions are generally perceived as evil. Chinese expect their guanxi partners to remain in apparent harmony under all circumstances and seek solutions to disagreements that provide as much satisfaction as possible for all parties involved. Therefore, in both domestic and international business activities, Chinese managers prefer to use bilateral negotiation or consultation as the first solution to disputes, followed by third-party mediation if needed. If mediation does not work, arbitration may be considered next. Lawsuits are rarely used unless all other solutions do not work. Figure 1.1 schematically summarizes the core elements in the conceptual framework of guanxi.

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20   Guanxi and Business Moral Behavior • Loyalty • Respect • Kindness • Love • Trust • Justice • Harmony • Peace Social Basis • Locality • Fictive Kinship • Workplace • Associations • Friendship

Social Modes (Wu-Lun) • Prince–Subject • Father–Son • Older–Younger Brother • Husband–Wife • Friend–Friend

Guanxi Concepts & Principles • Transferability • Reciprocity • Intangibility • Utilitarian • Context Specialty • Long-term Futurity • Personality

Social-Political Life

Business-Economic Activities

Chinese Society and Economy

Figure 1.1. Core elements in the conceptual framework of guanxi.

1.4 GUANXI IN SOCIAL LIFE Guanxi is a system used to exchange favors or fulfill private goals. Guanxi is an important resource that can be accumulated and exchanged. It is used at all levels of social life, from the smallest, everyday aspects to the most important events in a person’s life. For successful string-pulling (la guanxi), one’s network ideally should contain everyone from store clerks who control scarce commodities to cadres who have the final say over such things as housing

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allotments, residence permits, job assignments, and political evaluations needed for Youth League or communist party membership. What is special about guanxi in Chinese society is its instrumentality. Guanxi embodies the reciprocal obligations between parties involved in the acquisition of resources. Hwang (1987) explains why the instrumental use of guanxi arose and persisted in Chinese society in terms of both cultural and structural factors: “Surely, part of the answer is cultural. Through historical accident coupled with manipulation by political and cultural elites, in ways that we cannot now unravel, the Chinese have developed an elaborate vocabulary for thinking about interpersonal obligations and how they can be won or lost.... The other part of the answer is structural. Historically and, to an extent, even in modern contexts, many Chinese have lived in encapsulated communities that are hierarchically organized, with major economic and other resources controlled by a few power figures who could arbitrarily allocate resources. In these settings, it has been imperative to be sensitive to one’s social position and to the kinds of resources that one could elicit and be forced to give up through obligations incurred over long periods of time.”

The structural factor explains why the instrumental use of guanxi is more widespread in China than in other Chinese societies such as Taiwan or Hong Kong. In China, there has, until recently, been a top-down allocation of resources tightly controlled by the state. Coupled with a primitive legal infrastructure, guanxi has become a popular way to solicit favors from authorities who have control over scarce resources. Many guanxi ties are a mixture of the instrumental and the personal. In other words, some guanxi ties are strictly utilitarian, and some are very much tied to personal feelings. In any case, immediate instrumental purposes are usually subordinated to the aim of developing relationships that may serve as solving problem resources over long periods of time. The critical social capital of trust, not just obligation, is created through the repeated exchange of favors. Those who have ties within one sphere can exchange help in that area for aid in another area to which they otherwise have no

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access. For example, a physician may help a shopkeeper to get better or provide faster medical care; in return, she or he may receive first notice of the arrival of a new shipment of televisions. Another example concerns the use of guanxi in buying middle- or upper-class train or plane tickets during 1980s when the supply of these tickets was short. A friend in Beijing described how he was able to buy a sleeper ticket which was usually difficult to purchase: he approached his mother who works in a hospital serving railroad workers; she made a request to someone she knew at the train station office, who then wrote down her son’s name on a slip of paper and also made a telephone call to the ticket seller. The son then took the slip to the train ticket station where they actually have a special window booth just to sell tickets to guanxi hu or people with guanxi, got in line, and bought his ticket (Yang, 1994: 40).

Guanxi is also useful in other, more important, aspects of life. For instance, parents often use guanxi to secure entrance for their children into a university. Guanxi can be the difference between being assigned to a job in a distant city and being assigned near one’s family. Within a work unit (danwei ), guanxi is often involved in decisions about good positions or travel abroad. One of the most obvious examples of the importance of guanxi is housing. In urban areas, housing is in short supply; applicants often wait for years for an apartment. Guanxi is key to a shorter wait or assignment to better housing. Guanxi is often necessary to fulfill even basic needs. The shortage of goods and services reinforces the permeation of guanxi. Because shortages exist in all aspects of life, connections with people at all levels are useful and often necessary, as the following extract illustrates: A friend’s father needed treatment for a serious disease but because of the lack of available beds, was unable to get into an adequate hospital for treatment. After two weeks of waiting for the normal channels to work, during which his condition had worsened considerably, the family pulled guanxi to get him into the hospital. Through the help

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of old classmates and those classmates’ guanxi networks, they found someone who was able to put her father’s name at the top of the list of waiting patients. This family will in turn owe a favor to those who helped them, and will be expected to use whatever contacts they may have when called upon (Riley, 1994: 800).

All Chinese live in a web of social relationships. People’s family, kinship networks, colleagues, neighbors, classmates, friendship circles, and even casual acquaintances are the social communities into which they grow and on which they depend. These are much closer social structures to individuals than is the state party. The social relationships which surround an individual provide immediate expressive and instrumental support that the larger structure of the state government does not. Rationally, individuals cultivate and utilize social connections in order to satisfy personal interests. In exchange, they are obliged to assist others with whom they are connected. This implies that government officials at various levels often deliberately break party rules by assisting those people with whom they have guanxi. Because guanxi is a social force which counters bureaucratic control, the use of guanxi decreases when the bureaucracy is very strong. On the contrary, the effectiveness of interpersonal networking can deflect bureaucratic control over jobs. Guanxi therefore plays an essential role in allocating urban jobs in post-revolutionary China (Bian, 1994). It pervades every stage of the job assignment process. Connection to government officials, particularly those affiliated with the labor bureaus, gives people great freedom to choose the work unit to which they will be assigned. Guanxi can make the difference for a graduate between being sent to a desirable work unit such as a profitable state enterprise with better job security and welfare benefits and being sent to a small, remote collective enterprise where wages and benefits tend to be lower and the work harder. One graduate said recently that guanxi can be more important than one’s GPA in finding a satisfactory job. Government officials can initiate assignments for their guanxi partners by sending messages to associated officials in charge. Having guanxi in an organization which is recruiting employees is also useful because members of the organization can recommend their guanxi partners. School or residential authorities can also

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benefit from doing favors for organizations by adding names to a recommendation list to satisfy their own guanxi. Geographical migration is restricted by the elaborate household registration (hukou ) system established in 1958 under which every single urban or rural household had to register all its members with a local public security station. Registration at birth gives citizens the right to live in a particular village or district of a city. No household member can move to another city or province without filing for a change in household registration. This is a long, arduous, and usually unsuccessful bureaucratic procedure. Since getting permission to change one’s residence is one of the most important yet most difficult things a person might attempt, guanxi has been used extensively and intensively as a way of getting around bureaucratic control. Sometimes the cost of cultivating guanxi to effect this change can take several years of savings. Going abroad, whether to visit, study, or emigrate, is also extremely difficult. Guanxi comes in handy in getting permission from one’s work unit to leave or moving to the top of a passport waiting list. Although China is now experimenting with housing reform in some cities, most urban housing is still allocated by one’s work unit. Through state subsidies, rents are kept very low. As a result of budget or investment controls and low levels of retained earnings or funds, many work units are unable to provide enough houses for employees. Consequently, who gets houses, especially those in better condition or at good locations, is often determined by guanxi relationships between employees and top-level managers. Many young couples working in factories, universities, hospitals, schools, or stores have to wait several years in order to be allocated a room or an apartment unless they or their parents have solid guanxi with the authorities. Aufrecht and Bun (1995) argue that guanxi even affects the Chinese civil service. Chinese cultural values, namely, guanxi, Confucianism, and civil service examinations promoting scholar-rulers, are significant factors influencing the practice and reform of the Chinese civil service. Confucian values of filial loyalty, reinforced by the tradition of guanxi, enmesh the Chinese in a complex net of obligations to family and friends. This raises strong value conflicts for officials charged with making decisions based on merit. The Chinese leadership finds itself in the position of defining which cultural

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characteristics are to be preserved and which are to be suppressed. The merit system in the United States originated as a response to the abuses of the spoils system. Guanxi is a more sophisticated social and economic tradition. The lack of a really marketized economy in China makes it particularly tricky to alter the guanxi system. Guanxi is often used to promote one’s political or administrative position. It is often a factor in advancing one’s political career. Gifts are frequently sent to guanxi partners who have the power to influence one’s promotion. Guanxi is even necessary in order to keep one’s current status secure. Skillful guanxi cultivation is sometimes more significant in affecting job advancement than individual merit and contribution to the political organization. This may partly explain why, in recent years, many intellectuals have left governmental agencies for jobs in other companies and private businesses. Maintaining good health can also depend on guanxi if one wants to have a better service in the hospital contracted by the work unit or go to a more reputable hospital for treatment of a serious illness or surgery. Doctors are important people with whom to cultivate guanxi because, aside from providing access to hospital beds, having guanxi with a doctor can affect how seriously he or she listens to a patient and provides a good diagnosis. Moreover, doctors are a potential source for rare and potent medicines. They can also write sick leave permission slips so that one can take days off from work. Since most doctors have a powerful role in an overburdened system of state medicine, a role in stark disproportion to their working-class wages, they are often besieged by guanxi overtures from anxious patients but predisposed to become participants in guanxi relations. The combination of cultural norms and the socioeconomic and political situation in China means that guanxi ties are particularly important. A brief comparison with Taiwan underscores these differences. Many writers have discussed the importance of guanxi in Taiwan society (Hwang, 1987). Skill at managing a thick skin of human relationships is the most prized talent in Chinese society. It allows its possessor to create a sufficiently wide network of well-placed people to achieve his ends gracefully, efficiently, and without excessive expense (Gates, 1987). Indeed, use of guanxi in Taiwan and China reflects a common culture and history. However, the socioeconomic context

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in China necessitates a reliance on guanxi that is not present in Taiwan. Although kin and other networks are important in both societies, the type of economy and the inflexibility and lack of alternatives in China have served to underscore the importance of strong kin networks. In Taiwan, guanxi is helpful, but there are other routes to success; on the mainland, guanxi may often be the only way to get something done. Chu and Ju (1993) surveyed guanxi usage in Shanghai. Their findings indicate the importance of guanxi in social life. First, an overwhelming majority of those polled affirmed the importance of guanxi in daily life. Second, a strong majority indicated that they do not trust strangers until they have had the opportunity to get to know them better. Third, the majority preferred to use guanxi connections over normal bureaucratic channels to advance personal interests and solve problems. While realizing the importance of guanxi in affecting social and economic life, guanxi may in some circumstances have a negative impact on social welfare. For one, its benefits accrue to the individual rather than to the nation as a whole. Other negative aspects of guanxi are referred to as guanxiwang (guanxi net). Guanxiwang is criticized as arising out of the vestiges of feudalism and the idea of capitalist self-interest. Taking unfair advantage of guanxi results in abuse of power, it encourages the accumulation of self-wealth out of state property. It allows for unscrupulous allocation of interest in opposition to the spirit of socialist cooperation, equal competition, democracy, and law. Use of relationships to achieve personal ends is condemned as particularistic, subjective, and contingent, rather than cosmopolitan and objective. It can provide a hospitable environment for corruption and crime.

1.5 GIFTS, BRIBES, AND GUANXI Gift-giving is common in many societies. The custom of giving gifts at the beginning of a relationship can lead to trust and cooperation. Gift-giving practices, however, are often governed by strange and seemingly arcane rules in many societies. In the marriage market, for example, a hopeful suitor may buy a conventional gift such as a box of chocolates. He will remove the

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price tag even though the recipient will probably have a good estimate of the cost. He will enclose the gift in wrapping paper, even though he wants his prospective partner to unwrap it almost immediately. Then he will present it when he meets her at the door, before any meaningful conversation has begun. Such gift-giving practices vary substantially among different cultures. The suitor in the West would never consider giving money to the woman he woos, although chocolate is acceptable. If he did so, he might find the gift rejected and the door closed in his face. In Chinese society, however, money is the most important gift exchanged in arranging an engagement and marriage. If a friend invites you to attend her wedding, you must prepare a red envelope containing money, the amount of which differs across regions, periods, and the closeness of the relationship. Gift-giving practices in China are part of a dynamic process which must constantly be trained and perfected. Yang (1994) argues that the gift economy is one of the three modes of exchange in China (along with the state redistributive economy and commodity economy). The gift economy consists of the personal exchange and circulation of gifts, favors, and banquets. As an intrinsic part of the art of guanxi, the gift economy alters and undermines the structural principles and smooth operation of state power in China. Strictly speaking, gift-giving is an imperative for “getting in by the back door” (zou houmen ) but not necessary in all guanxi connections. Zou houmen has become less important since 1978, with the Chinese economy becoming decentralized and firms enjoying more autonomy. “Pull guanxi” (la guanxi) has arisen to take its place. This implies that guanxi cultivation is becoming increasingly commercialized and commodified. Gift-giving is becoming more common in initiating new guanxi rather than zou houmen, although its effectiveness cannot be guaranteed. The art of guanxi also seems to have become more masculine. Unlike traditional rurally derived renqing, guanxi has emerged in a post-revolutionary context where people have had to deal with a modern state more powerful and socially pervasive than any other in China’s long history (Yang, 1994). Guanxi arose as a way to defuse and subvert the elaborate regulations and restrictions that the state redistributive economy imposed on everyday life. In this engagement with the state, the art of guanxi has become more instrumental, hardened, cynical, and politicized than renqing. That is, it

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has adopted some of the masculinist features of the state. In addition, the guanxi gift economy has also served in many ways as a substitute for market relations, which were severely curtailed by the redistributive and planned economy of state socialism. In this process, the art of guanxi has also become more instrumental and commodified as a kind of means-ends relationship (Yang, 1994). This holds true for Americans doing business in China. Empirical research on gift-giving and guanxi shows that American gift-giving is associated with higher levels of environmental uncertainty, greater frustration with Chinese associates, and a general lack of performance gains (Abramson and Ai, 1997). Although guanxi construction and maintenance do not require gift-giving, giving gifts is a Chinese tradition that can indicate goodwill or respect. Chinese guanxi gifts have, however, traditionally been foodstuffs. Money was only given as a gift to the head of a household on occasions related to engagements or weddings. The use of money or financial benefits as guanxi gifts by Westerners has more to do with the significance that money has for Westerners than with traditional Chinese guanxi expectations. This can lead to cross-cultural misunderstandings. When guanxi is based on inappropriate gift-giving, the Chinese regard the guanxi created as unauthentic and believe that any obligation created is intentionally limited and of a short term. An overemphasis on gift-giving can be construed negatively as bribery. The gift exchange and market exchange are not necessarily opposites. They can be complementary. Guanxi lies in the skillful mobilization of moral and cultural imperatives such as obligation and reciprocity in pursuit of both diffused social ends and calculated instrumental ends. Individuals and firms use guanxi to cope with bureaucracies that increase the difficulties of everyday life and to substitute for missing market mechanisms. Gift exchange differs from the exchange of commodities in that the former is inextricably tied to the relationship between the transactors. In contrast to gift exchange, bribery, barter, the black market, and the legal market economy all feature transactions which are not embedded in social relationships other than those dictated by purely economic motives (Yang, 1994). The style and manner of gift exchange is not optional. Although a relationship may be cultivated with instrumental goals foremost in mind, specific cultural formalities must be followed if the goals are to be achieved.

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The relationship itself must be presented as primary; the gift exchanges, useful though they may be, are treated only as secondary. If it becomes apparent that the relationship involves only material interests and is characterized by direct and immediate payment, the exchange is classified as bribery. Although personal influence is important in business, it can only go so far before it becomes bribery. The use of bribery, seen as the offer of personal gain for a non-reciprocal favor, is universally condemned. Giving cash for a favor is usually deemed as bribery because of the connotation of buying someone’s services. Although the use of money as a present is not enough to define an exchange as a bribe, since wedding gifts are usually cash, an offer of money is, in most circumstances, an indication of bribery. Gift-giving may be viewed as guanxi cultivation or bribery, depending upon the underlying objective of the person who gives the gift. If a governmental official takes money in exchange for providing help, it is a bribe. If one gives a person a birthday gift, however, it is relationshipbuilding. If one spends money by taking someone out to tea, it is not bribery. Strengthening preexisting social connections is a much more reliable strategy than bribing unconnected officials. Gift exchange may be considered a bribe rather than ganqing development if no countergift is expected (e.g., no reciprocity) or if the exchange is a one-time deal. Where the reason for the gift exchange is not to create ganqing, but simply to achieve some immediate objective for which the relationship would be useful, then even though the form of the gift is followed, its content is different. It is a deal or a bribe rather than a gift. Manipulative and exploitive uses of gift exchange are made possible only by the existence of forms of gift exchange that attach priority to the relationship. Reliance on people with whom one has strong social connections includes asking them for advice about which gift-giving cannot be avoided and how to minimize expenses without losing face. This is a much more effective approach in constructing sustainable guanxi than more shallow exchanges. The above distinction between gift and bribe builds upon the social meaning of bribery. Legally, a bribe is defined as an improper influence over the performance of a public function that is meant to be gratuitous. Impropriety may consist breaking the law or explicitly subordinating the relationship to instrumental aims. In China, there are both legal and informal

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social aspects to the concept of the bribe. The difference between acceptable gifts and improper bribes depends on arbitrary, delicately poised cultural conventions which, moreover, vary according to context. This makes the enforcement of anti-bribery laws very difficult in China. What is acceptable reciprocity at one place or time may be viewed as corruption at another place or time. One’s commission or consulting fees could be redefined as bribery in other contexts. The processes by which individual transactions become labeled and prosecuted as corrupt involve more than just fitting the behavior to the law, but also examining the transactional relationships between the suspected corrupt individuals and the investigating officials. Ironically, one of the most effective strategies for protecting oneself against such charges is to cultivate the right guanxi connections. To differentiate between acceptable gifts and normal income from bribes, the Chinese government pays more attention to the objective behind the exchange. It considers whether or not the provider uses governmentally delegated power for the exchange, whether or not a particular “fee-for-service” activity is legally allowed, and whether or not the exchange affects the public or provides state benefits. Business ethics in China rests upon a rich and diverse cultural moral heritage that emphasizes personal virtue (de  ) and a right ordering of personal relationships in social organization and institutions. The most prominent forbearers of this tradition are Confucian, Daoist and Legalist schools of thought, as well as a very strong influence derived from Buddhism. In modern times, Western Enlightenment philosophies of business and society have come to exert increasing influence on Chinese approaches to business ethics. Chinese ethical traditions are long, nuanced, and complex. Traditional Chinese approaches to ethics are communitarian and emphasize a path or a way to follow to achieve moral integrity. Such a pathway of ethical behavior has given expression to concrete criteria of virtues and moral character. For example, the virtue of ren expresses complex notions of benevolence, kindheartedness, and humanity that form the basis of the notions of other virtues (righteousness, sincerity, trustworthiness, responsibility, and justice) in both personal conduct and social institutions. While the underlying traditional Chinese cultural logic provides the fundamental ethos of business practices, social knowledge of guanxi and proper conduct (li  ) provides a clearer map of routinely expected ethical

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patterns of behavior. For example, belonging to a network of personal relationships is both a matter of highest intensity in China as well as a universal primary ethical reference point in judging what one ought to do. Gift-giving is an integral part of right relationships and expected behavior, which shows respect to another person, while strengthening the commitment and reciprocity of such relationships. The practice is, however, bounded by rules of moral legitimacy. Both guanxi and the social stature of face are enshrouded in public rituals, which express status, respect, and bonding in terms of formality. There is a very important ethical difference between the morally and socially acceptable standards of conduct, which are thought of culturally as necessary to moral order in society and law. The Confucian concept of li refers to religious and social standards of proper personal conduct and the right ordering of relationships between people in social institutions that is necessary to maintain a moral order in society. This concept embodies the notion that positive moral laws and codes are unwarranted because acting contrarily to public rituals would result in interpersonal and social sanctions with far graver consequences than any embodied in a penal code. Juxtaposed with the concept of li is the legalistic concept of fa (law). Fa is something of a necessary evil that is needed to ensure a moral society when virtue fails. In theory, law is reserved only for those so low on the moral stratum that they have forsaken the ethics of right relationships. Moral behavior, therefore, tends to exalt virtue and downplay codified law.

1.6 IMPORTANCE IN THE FUTURE The importance of guanxi in the future is debatable. One may argue that as China’s economy develops, greater emphasis will be placed on institutional law, hence mitigating the necessity for guanxi. Others contend that guanxi will continue to be important. An overview of economically advanced or more developed Confucian societies — Japan, South Korea, Hong Kong, Singapore, and Taiwan — shows that the establishment of institutional law has not displaced reliance on personal connections. Maintaining relationships is among the core values of these societies.

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My response to this debate is as follows. First, it is necessary to differentiate blood-based versus socially based guanxi when assessing its importance for the future. Socially based guanxi is generally more vulnerable to the strength of institutional law enforcement than guanxi based on blood relations. The necessity for cultivating socially based guanxi is likely to diminish as the strength of institutional law enforcement increases. Blood-based guanxi is less contingent upon structural reforms and institutional changes. It is deeply rooted in Chinese culture. Bloodbased guanxi will therefore remain important in affecting social and economic life in China. Second, as the state government provides greater autonomy, resources, and power to local governments, guanxi with central government authorities will become less important than guanxi with local officials. In other words, the importance of guanxi with the former may decrease, whereas that with the latter may increase. Since the State Council and a few key economic commissions or ministries which control scarce resources will remain in power, guanxi relationships with officials in these departments will remain significant. Third, as China is becoming demoralized, there will be higher intertwineability or inseparability between guanxi and corruption. I expect to see more corrupted guanxi and more guanxi-based corruption, both of which could propel instrumentality, opportunism, and dishonorability, a danger to China’s social and economic development. Lastly, we will witness greater diversity in terms of the importance of guanxi to different individuals and organizations. The Chinese economy will present greater diversity in organizational ownership and higher disparity in individual incomes. The industrial environment will become more competitive and, consequently, require superior productivity and competency. When the shortage economy disappears and the utility function of those who have sufficient purchasing power can be easily and immediately satisfied by market supply, different individuals will have idiosyncratic needs for guanxi. Similarly, firms equipped with better technological and organizational skills will have less necessity to cultivate new guanxi networks.

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1.7 THEORETICAL DIRECTIONS Although many have written of the necessity for good guanxi when doing business in Chinese society (Alston, 1989; Kao, 1993; Luo and Chen, 1996), few have placed this business practice into a theoretical context. Because of the central role that guanxi plays in affecting business conduct and social life in the Chinese context, a more refined, theoretical approach for improving understanding of guanxi is warranted. I offer several suggestions for future research taking insights from this study as a point of departure. First, as guanxi is such a complex, long-rooted, and nebulous term, associated with management, marketing, and economics as well as sociology, anthropology, psychology, organizational behavior, and human resource management, further development of a mid-range theory of guanxi in a cross-disciplinary, integrated manner is needed. To improve understanding of the relationship between guanxi and business, all the relevant paradigms and models from the above fields should be logically incorporated, properly integrated, and related to firm operations. These theories will need adjustment before they can be used to study and interpret guanxi. As Shenkar and Von Glinow (1994) point out, organizational theories developed in the Western context vary in their degree of applicability to the Chinese context. While some theories are capable of identifying key environmental and cultural variables, the relative importance we attach to them remains embedded in parochial assumptions. Broadly, some insights derived from macro- and micro-organizational theories, such as the structural connection model (Granovetter, 1985), similarity-attraction hypothesis (Byrne, 1971), social identity paradigm (Tajfel, 1982), psychological group model (Turner, 1984), resource dependence model (Pfeffer and Salancik, 1978), and configurational approach (Meyer et al., 1993) could all be useful in developing an integrated theoretical framework for guanxi. Second, because of the paucity of research on the issue, we know very little about the actual mechanism through which guanxi is created. The linkage between the powerfulness of guanxi and firm performance is also absent. More valuable insights into the dynamic effect of guanxi and its performance implications could be gained from research that traces guanxi construction

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processes in detail over time. Preliminary studies by Davies et al. (1995), Luo and Chen (1996), and Xin and Pearce (1996) offer a starting point on the interrelationship between the guanxi mechanism and its organizational and managerial effects. A more robust theoretical framework is needed to illuminate the process of guanxi network building and the structure of guanxi utilization. Future research should also pay more attention to the influence of environmental factors on these processes or structures because both internal structures and external conditions of firm operations are drastically and constantly changing. Since the degree and pattern of guanxi applications are influenced by the characteristics of industrial and market structures (e.g., vigor of competition, governmental policy, structural variability, and scarcity of resources), it is necessary to incorporate industry- and marketspecific factors into the framework. In addition, the extent of governmental intervention and hindrance in firm operations needs to be captured. This extent determines the degree of necessity for a firm to build and maintain guanxi with bureaucrats at various levels of authority. Furthermore, regionspecific factors should be included. Economic development and policies are uneven across different areas. The business atmosphere and cultural values are also heterogenous in different regions, particularly between the eastern coastal provinces and the central and western inland areas of China. These multiple heterogeneities may combine to either facilitate or intervene in the role of guanxi in relation to firm performance. Third, an additional research avenue resides in the association between organizational attributes and guanxi formation and application. It would be a worthy effort to link the types of Chinese domestic firms (state-owned, collectively owned, and privately owned) to guanxi construction and utilization. Along with the transformation of economic structure, collectively owned and privately owned enterprises have played an increasingly significant role in shaping the economic environment. These non-state-owned firms are deemed to rely more heavily on guanxi for sourcing and marketing and are thus more vulnerable to guanxi dynamics (Xin and Pearce, 1996). It would also be worthwhile to assess the different ways guanxi is used between local Chinese firms and foreign ventures. The peculiar characteristics of some foreign ventures, such as entry mode (equity or contractual joint venture

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vs. wholly foreign-owned subsidiary), country of investment origin, partner selection, sharing arrangements, product diversification, and investor’s experience, determine a venture’s market orientation and its interaction with host conditions. These characteristics, therefore, may have different impacts on the creation and application of a guanxi network. Moreover, the role of guanxi in a firm’s operational and financial outcomes may be facilitated or impeded by firm attributes (e.g., industry experience, length of operations, and market share), product attributes (e.g., quality, innovation, and cost), and management team attributes (e.g., personality, sociability, leadership style, and personal relationship with government officials). These attributes certainly deserve scrutiny in future research. Lastly, the proper operationalization of guanxi has been neglected. One possible approach lies in assessing four inflections on the conduct of social relationships: (i) emotional affect, as it differentiates guanxi from bribery or impersonal money relations; (ii) feelings of diffused obligation that distinguish guanxi from either bribery or ganqing; (iii) etiquette and propriety of conduct that make guanxi different from bribery, loyalty, or the ethic of righteousness (yiqi ); and (iv) gain-and-loss calculations which enable the researcher to differentiate guanxi from ganqing or yiqi which, strictly speaking, possess zero instrumentality. Guanxi certainly possesses a heavy dose of gain-and-loss calculation and means-ends concerns for material gain, but these concerns can only be expressed and satisfied through various social bonds of affect, obligation, and propriety. Guanxi can only be activated by employing or playing on the idiom of friendship and kinship as well as by adopting the language and decorum of renqing, yiqi, and ganqing. The intersection of guanxi with the discourses and practices of yiqi, qanqing, and renqing are what make it distinct from impersonal money and bribe relations. In conclusion, most researchers in the 1970s and 1980s literature explained what guanxi is. The majority of early studies since then have addressed why people and organizations need guanxi. It seems that academics now need to consider more about how guanxi may generate unintended social consequences, how we alleviate such negative consequences, and how we place ethical awareness and relational norms in guanxi development to truly transform guanxi into relational capital.

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1.8 FUTURE RESEARCH AGENDA It is inspirational to see that previous studies have employed a multiplex framework to define firm performance involving financial, market, competitive, social, and overall aspects. Still, the area for improvement lies in the organizational aspect of performance — how guanxi affects leadership performance, corporate culture, organizational justice, firm credibility, employee turnover, workforce productivity, institutional legitimacy, and managerial efficiency, to name a few. Additionally, most studies have assumed a linear relationship between guanxi and performance. This may not be always the case, however. It is reasonable to anticipate that the cost of building guanxi and the value of using an established guanxi are neither stable nor constant. Hence, it is highly warranted to propose and verify a curvilinear, U-shape (or inverse U-shape), and J-curve (or lie-down J-curve) relationship between guanxi and performance in future research. Future inquiries may also look at additional conditions or facilitators that may affect the guanxi–performance link. Comparatively, extant research focused more on moderating effects than on mediating effects. This is logical because guanxi is deemed to add more value to performance under congenial conditions where other forces nourish or complement guanxi’s contribution. Yet, we know quite little about the mediating path. Plausibly, guanxi may improve firm performance through certain process intermediaries (e.g., increase in client pool, improved resource endowment, amplified business networks or alliances), and such intermediaries may play an important mediating role. In a channel setting, for example, guanxi with channel partners may facilitate performance under the mediation of knowledge and resource sharing (Gu et al., 2008). Besides, there might be other moderators not addressed in the field. Firm strategy, organizational form, and developmental stage could be moderators too. It is likely that guanxi has differential effects on performance as a firm grows with different corporate and business strategies, is governed by different ownership or organizational forms, or undergoes different relationship stages with business partners. Considering guanxi being endogenous rather than exogenous, it is well merited to put more efforts investigating the antecedents, determinants,

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and predicting forces of guanxi in the guanxi–performance model. Guanxi is produced, developed, and leveraged under the enormous influence of organizational needs and environmental conditions, giving rise to multilevel antecedents (e.g., national, industry, firm, team, and individual levels). Accumulated research on guanxi addressed some of these antecedents at best, calling for more diagnostic efforts to unpack such antecedents as strategic, entrepreneurial, and market orientations; managerial visions and philosophies; industry-level dynamics; and developmental stage of firm growth. Finally, future studies are encouraged to conduct more longitudinal studies to empirically test the shifting role of guanxi with the progress of the market transition in China. Such endeavors would allow us to test the co-evolution view toward a firm’s networking strategy along with the institutional environment change. Co-evolution may exist because guanxi, somewhat tantamount to corporate lobbying in developed countries, can be used to shape or change the institutional and competitive environment. Case studies and survey research, both with the longitudinal information, may shed light on this story.

1.9 PRACTICAL EXAMPLES Minicase 1: Guanxi is His Middle Name Between courses of duck and chicken-and-ginseng soup at a June 1997 dinner in Beijing, an influential Chinese official perks up at the mention of US Ambassador James R. Sasser. In a refrain now common in Beijing’s corridors of power, he praises the former Tennessee senator: “He’s straightforward and sincere. And he knows Clinton very well.” Human rights, trade frictions, China’s defense spending, Donorgate — the sources of friction between Beijing and Washington seem endless. Many Americans regard China with deep suspicion, while the Chinese routinely lash out at America’s meddling ways. But in Beijing, policy-makers agree on one thing: Jim Sasser is a helluva guy. They don’t care that many people in Washington see Sasser as a partisan politician with limited foreign policy

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experience. Here in Beijing, the 60-year-old diplomat is something else: a peacemaker and the man who can interpret America’s byzantine foreign policy practices to Beijing’s often bewildered cadres. Says Sasser, “I’m out here trying to explain how we do things.” Sasser’s approach has been to work his Beltway connections for all they’re worth. Since taking his post in early 1996, he has been returning to Washington every two to three months to press for more US–China contact. As a result, Secretary of State Madeleine K. Albright, Vice-President Al Gore, and Federal Reserve Chairman Alan Greenspan, as well as one in five members of the House of Representatives, all visited Beijing in 1997. Similarly, Chinese officials such as foreign minister Qian Qichen and Defense Minister General Chi Haotian have been to Washington. In a surprising display of accessibility, Beijing’s top leaders have been meeting with almost every American visitor, right down to the lowliest junior congressional representative in town. That’s a result of Sasser’s efforts to convince Beijing of the importance of Congress and of how it can hold China policy hostage. “[The Chinese leadership] has learned a lot about how America works recently,” says John Holden, chairman of the American Chamber of Commerce in Beijing. The local US business community is especially grateful to Sasser. He regularly passes business concerns on to the Chinese ministries and even visits far-flung provinces to promote American interests. Earlier this year, he successfully pressed foreign minister Qian and executives at Air China to buy five Boeing 777 jetliners. What’s dogging Sasser is his reputation as a pushover at home. The Chinese like Sasser because “they figure he’s nice and he’s weak. He won’t cause problems,” says one former US Administration official. And many still view Sasser as simply a political appointee. Sasser defends his approach, “I don’t think it’s the role of any ambassador to gratuitously offend the country he is credentialed to.” And he feels he leans on the Chinese when necessary. In a speech earlier this summer, he warned the Chinese to watch their step during the important period of Hong Kong’s handover. And he brushes off the Beltway critique that he’s nothing but a politician. “China welcomed a political appointee,” he says. “They were pleased to get someone who could communicate their views directly to the administration.”

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One danger with Sasser’s approach is that his own reliance on contacts back home could backfire. By overemphasizing Sasser’s role in the overall guanxi relationships, China may feel safe in ignoring the many demands coming out of Washington. Source: Adapted from Dexter Roberts, “Guanxi is his middle name,” Business Week, July 21, 1997, p. 46.

Minicase 2: A Smuggler with Guanxi A big political question for Hong Kong, just before the Chinese takeover in July 1997, was who would run the place after the present governor, Christopher Patten, left. Speculation started early in 1996 and intensified when a local reporter asked Hong Kong businessman Henry Ying-tung Fok whom he thought the next leader would be. Fok’s reply: shipping executive Tung Chee-hwa. Suddenly Tung’s face was plastered across the local media and the international press as the next man most likely to run Hong Kong. Who is Henry Fok, and why do people in Hong Kong and Beijing give him such credence? A figure cut from a James Clavell potboiler, Fok, 73, is a member of the ten-person inner circle of something called the Preparatory Committee, consisting of 150 prominent Hong Kong and mainland China residents who advised Beijing on the hand-over of the colony. This inner circle held most of its meetings in Beijing; the proceedings were kept strictly private. Significantly, businessman Li Ka-shing and many other prominent Hong Kong billionaires were not members of this inner sanctum. Fok’s influence stems from having some of the strongest guanxi (connections) in Hong Kong with the Chinese Communist elite. Guanxi is more than simple networking. A person with strong guanxi has done favors for other people, and is therefore owed favors in return. Fok performed a huge favor for the Chinese Communists during the Korean War. Western nations had imposed a trade embargo on China for its support of North Korea. Fok, then in his late 20s, broke the embargo, using boats and trucks to smuggle much-needed medicine, spare parts and other supplies from Hong Kong into the People’s Republic.

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The smuggling was motivated by poverty, not ideology. Fok was born in 1923 to a seamstress and a cargo ship’s deckhand. After his father was killed in an accident at sea, Fok took a series of odd jobs, once working as a coolie earning half a pound of rice and 75 cents a day. He carved out a living harvesting seaweed for export to Japan. By the Korean War’s end in 1953, Fok had reaped enormous profit from his smuggling operations. He began buying buildings in Hong Kong and soon became one of the city’s leading developers. In 1962, Fok and some partners, including fellow billionaire Stanley Ho, snagged a controlling interest in the hugely profitable casino monopoly in the neighboring Portuguese enclave of Macau. Fok, Ho and partners still have that business. FORBES estimates the Fok fortune at US$2.5 billion. Throughout his rise, Fok continued to build his guanxi. In 1985, for example, he had donated US$130 million to set up a special educational foundation on the mainland and helped draft the Basic Law, an agreement between England and China that laid the groundwork for the 1997 handover. He also became a member of the NPC, China’s highest law-making body, and rose to become Hong Kong’s highest-ranking member. Fok has connections with the US too, but of these he would rather not speak. In 1991, his son Thomas was arrested at New York’s Kennedy Airport for attempting to smuggle 15 000 AK-47 machine guns into the US. Henry Fok denied any knowledge of his son’s action. Thomas Fok pled guilty and served six months in an upstate New York jail. In promoting Tung Chee-hwa as Hong Kong’s next governor, Fok is lobbying for someone who owes him a big favor. In 1986, the Tung family’s shipping firm, Orient Overseas (International) Ltd. (inherited from his late father, C.Y. Tung), was about to go bankrupt. At the last minute Fok stepped in with a US$120 million investment. That, and his implied seal of approval, helped save the Tung firm. Fok still owns a three percent stake. One well-placed source (he asks to remain nameless when discussing Fok) says, “Henry Fok could become the next leader of Hong Kong just by asking the Chinese for it.” But Fok seems to have concluded that he can exercise all the power he wants through this man, Tung Chee-hwa, while maintaining the very low profile he craves.

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Source: Adapted from Justin Doebele, “A smuggler with guanxi,” Forbes, November 18, 1996, p. 161.

Minicase 3: American Regulators Investigate JPMorgan Chase’s Hiring in China Of all the investigations and lawsuits affecting financial firms in America, few have wider ramifications than a reported probe by the Securities and Exchange Commission (SEC) into whether JPMorgan Chase hired the children of senior Chinese officials in order to help the bank win business. One recruit was the son of an ex-banking regulator who is now the chairman of the China Everbright Group; another the daughter of a railway official (JPMorgan Chase has not been accused of wrongdoing and says it is co-operating with the investigation). The probe will cause amazement in China, a country in which the idea of guanxi is ingrained. Familial connections are rife across government and commerce. The investigation will also cause consternation at Western firms hoping to do business in the country. Investment banks in Hong Kong privately concede that finding a “princeling” who is valuable for reasons other than their connections is the exception, not the rule. Although America’s Foreign Corrupt Practices Act (FCPA) specifically targets the bribery of government officials, many of China’s largest companies retain strong government ties so may come within its ambit. The SEC’s scrutiny comes after the conviction last August of a Shanghai-based employee of Morgan Stanley for bribing a government official. Some banks are now considering whether unpaid internships could be considered bribes by American regulators. Even an uncompensated spell at a prestigious firm has genuine value for the recipient, and could provide a useful contact for the bank. If hiring princelings becomes a potential red flag to investigators, banks will presumably have to demonstrate that people are being hired on their own merits. But how to define “merit”? For young employees, the universities they attended are often cited as proof of ability, but in many countries, not least America, entry to the best universities can also be a product of family relationships.

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Chinese entities are not the only ones where these issues arise. American investigators are also interested in sovereign-wealth funds, another messy meld of government, commerce and money. Banks will think twice about hiring people with relatives at these funds. Connections also count in the West, of course. Following initial reports of the SEC’s investigation in the New York Times, a flood of stories have noted the jobs held in politically sensitive American firms by the sprogs of American politicians. Even when offspring are not involved, the revolving door between the public and private sectors raises questions about why people are hired. JPMorgan Chase did not hire Tony Blair as a senior adviser for his knowledge of risk weights, after all. Mary Schapiro, a former head of the SEC, recently joined Promontory, a consultancy packed with ex-regulators used by banks to cope with regulation (she has said she will not lobby any government body in her new role). If it is unfair to cite these names, it is only because there are so many others. If the regulators genuinely fret about why firms make hiring decisions, they may want to extend their inquiries to Washington, DC, and New York as well. Source: Adapted from “Blood and money; Recruitment and connections”, anonymous, The Economist, London, Vol. 408, Iss. 8850 (Aug 24), 2013: 64.

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2 ECONOMIC SOCIOLOGY OF GUANXI

Guanxi is a valuable asset for its possessor and aids in gaining economic rent. Although it does not necessarily add value to the social welfare of the nation, guanxi has strong economic foundations which are sustained despite dynamism. This chapter first illuminates the economic rationale of guanxi, then explains the difference between Chinese guanxi and Western networking. The following section elaborates on guanxi as a necessity for achieving a competitive edge in the Chinese market. Managerial implications of guanxi are illustrated next, followed by a section that articulates the use of guanxi by overseas Chinese businesses. The last section provides some practical examples of guanxi in relation to its economic value.

2.1 ECONOMIC RATIONALE OF GUANXI Social Capital Guanxi is a form of social capital which creates economic value. Unlike economic capital, in which money or commodities are incorporated into circuits of production in order to produce more money, social capital is an aggregate of actual or potential resources linked to the possession of a durable network of more or less institutionalized relationships. Mutual acquaintance and recognition provide credentials which entitle people to various kinds of credit (Bourdieu, 1986). Social capital includes obligations (not debts in the economic, legally enforceable sense), the advantages of connections or social position, and trust. Connections and obligations are not given; they

43

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are the product of investment strategies consciously or unconsciously aimed at establishing or reproducing social relationships that will be directly useful in the short or long run. Social capital is fundamentally tentative and insecure, unlike economic capital which is objective, certain, and enforceable. Social capital, designated by such things as obligations and trust, is by its very nature vague and unmeasurable. Obligation is always a potential rather than a concrete actuality. Once it has been used, it does not exist anymore. Until then, there is no certainty that the obligation will actually be reciprocated. It is nebulous because of the forms in which it is created, such as exchanges of favors or gifts. Obligations created in such ways are implicit; otherwise they would be deals or bribes. The kinds of resources referred to as social capital are social because they are produced within particular social relationships. Although social capital can be converted into other forms of capital, it cannot be possessed. It is therefore contingent on the persistence of the social relationships within which obligation or trust is contained. If obligations can, in fact, be enforced and imposed on the obliged party by third parties, then they are economic capital rather than social capital. In social capital, explicit claims are normally excluded from the performances within which they are made, so that the power over the actions of others is radically distinct from the exercise of power which utilizes the discourse and apparatus of command. Knowledge or skill concerning the cultivation and maintenance of guanxi can be termed cultural capital. Cultural capital is a claim to having the ability to engage in certain types of practices. In its strongest forms, it accords a monopoly over such practices. Cultural capital is embodied within those who know how to do certain valued practices such as building up, strengthening, and maintaining guanxi. In general, cultural capital consists of what the agent knows and is capable of doing; it can be used to generate privilege, products, income, or wealth. Cultural capital can be gained individually through the processes of education, learning, and cultivation. It can also be institutionalized, as when certain forms of cultivation are accorded recognition by authorities. This is particularly likely when a monopoly over certain privileged positions is accorded to those who possess the proper credentials. The institutionalized forms of cultural capital can

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be torn down but the knowledge on which accreditation was based cannot easily be removed. Among businesses operating in China, foreign companies encounter the liabilities of foreignness in guanxi cultivation and development, whereas local firms have an important edge when it comes to cultural capital acquisition because they already have much of the necessary knowledge.

Economic Necessity Guanxi seems to be the lifeblood of the Chinese business community, extending throughout politics and society (Kao, 1993). Although the Chinese government has enacted thousands of laws, rules, and regulations, few are completely enforced since personal interpretations are often made in lieu of legal interpretations. Therefore, guanxi ties are very helpful in dealing with Chinese bureaucracy. Rather than depending on an abstract notion of impartial justice, the Chinese people traditionally prefer to rely on their contacts with those in power to get things done. A practical consequence of guanxi is that personal connections and loyalties are often more important than organizational affiliations or legal standards. For instance, whenever scarce resources exist, resources are allocated more by guanxi than by bureaucratic rules. Guanxi provides a balance to the cumbersome Chinese bureaucracy by giving individuals a way to circumvent rules through the activation of personal relations. In essence, while the Chinese bureaucracy often inhibits action, guanxi facilitates it (Alston, 1989). Developing, cultivating, and expanding one’s guanxi have become a common preoccupation and a form of social investment (Wall, 1990). One of the major underlying rationales behind this behavior is attributed to the economic legitimacy of guanxi. The institutional uncertainties in the Chinese society, most notably mainland China, have been considerably high. China’s post-Mao market economy lacks many of the mechanisms deemed necessary by conventional wisdom for a functioning market economy. Property rights are poorly defined and haphazardly enforced. There are few horizontal channels for disseminating information on supply and demand, and the bureaucracy is the dominant integrative structure in the social order. Under these circumstances, transaction costs are bound to be fairly high. Such an environment leads firms to “internalize” transactions in order to avoid

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turbulence (Williamson, 1975). Expansion and acquisitions, an alternative of internalization widely adopted from the West, often bear a high possibility of firm liquidation or spin-off. However, this is traditionally unacceptable according to Chinese social standards. In such a case, both parties of the acquisition would lose “face,” which greatly harms the potential for doing future business. As a result, the dominant logic of reliance on personalized exchanges leads Chinese firms to choose a guanxi-based strategy of growth, by building loosely-structured networks (e.g., guanxi hu) to facilitate economic exchanges while avoiding the institutionally difficult tasks of ownership transfer (Luo and Chen, 1996). According to transaction cost theory, there are three structural alternatives: internalization via hierarchy, market-based exchange, and hybrid structure. Williamson (1991) suggests that the hybrid form relies on contractual safeguards and increased information disclosure to reduce opportunistic behavior. At moderate levels of asset specificity, the hybrid form incurs fewer transaction costs than market-based exchange by reducing incentives to act opportunistically. Hierarchies are superior to the hybrid form in their ability to allow for incomplete contracts. Incomplete contracts reduce transaction costs by decreasing documentation and arbitration costs while increasing access to information and allowing for internal dispute resolution and alternate incentive options. Thus, hierarchies maintain an advantage over both market exchange and the hybrid form at higher levels of asset specificity. A guanxi business network is an organizational form that is neither a market nor a hierarchical and formal interorganizational alliance. Such a network helps a firm overcome its resource problems so that it can grow while avoiding the substantial bureaucratic costs which come from internalizing operations. Firms engage in extensive networking activities based on guanxi and informal agreements based on trust and favor exchange. Guanxi partners build loosely structured networks to coordinate activities, pool resources, and pursue joint growth (Peng and Heath, 1996). Firm boundaries become blurred in this context of multiple network connections without direct ownership. Guanxi-based exchange is established through interpersonal relationships. The loss of “face” of an individual can result in system-wide negative effects.

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That these effects transcend interpersonal relationship indicates institutional constraints. This suggests that guanxi-based exchange is a structural alternative to markets, hierarchies, and the hybrid form. The transaction cost advantage of guanxi-based exchange specifically results from the way guanxi deals with issues of opportunism. Because knowledge of individual “face” travels quickly through a guanxi network, the threat of ostracism associated with opportunistic behavior leads to a reduction of opportunism if the guanxi network is well developed. The cost of opportunism is the potential loss of exchange opportunities with all members of the network. Therefore, guanxibased exchange offers the advantage of reduced opportunistic behavior. Information market imperfection in a transitional or uncertain environment also necessitates the emergence of guanxi hu . Information passed through guanxi hu from reliable sources is far more trustworthy, richer, and more useful than that gained by other means. Thus, it saves on research costs and allows guanxi hu partners to make more informed decisions. In addition, guanxi hu connections can provide flexible resource allocation in an environment where factor mobility is severely constrained and administrative intervention by the government is still immense (Boisot and Child, 1988). By pooling and coordinating resources, organizational learning can occur. For instance, when a guanxi hu partner has been exposed to Western technology through licensing or joint ventures, it may help diffuse such knowledge throughout the network. As a result, better use of excess resources can be accomplished and more competitive products can be generated. The nature and pattern of economic transformation in China also stimulates pervasive guanxi-based business connections. This economy is characterized by undeveloped market structures, poorly specified property rights, and institutional instability which makes market exchanges uncertain and costly (Nee, 1992). Economic transformation has weakened the planning regime and decentralized macro-economic control. Unfortunately, the necessary formal constraints over a market-based economy, namely a welldefined legal framework concerning property rights, are also lacking. This situation has inevitably resulted in a sharp rise in opportunistic behavior and higher transaction costs. The lack of a stable political structure and

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developed factor markets further compounds the volatility and unpredictability of the environment, which has a strong bearing on a firm’s strategic choices (Shenkar and Von Glinow, 1994). Under these circumstances, state firms seek informal constraints characterized by network-based, personalized exchanges (Child, 1990). At the same time, although with greater operational autonomy, collectively and privately owned firms have more difficulty gaining access to scarce raw materials and other resources and getting governmental assistance. Good guanxi connections constitute a substitute for institutional support in these circumstances. Although the central and local Chinese governments have relinquished control over firm operations and management, they still exercise control over resource distribution, investment size, industrial structure, bank loans, and business formation in strategic sectors. Administrative interference, along with fiscal and monetary policies, often plays the biggest part in monitoring and directing recent economic development (Warner, 1995). Bureaucrats in the central government and local authorities have the power to ratify projects, allocate resources, arrange financing, supply raw materials, provide access to the infrastructure, assist with distribution and promotion, and the like. Firms have strong incentives to cultivate guanxi with these bureaucrats. A supplier will reduce its quota for government contracts so it can trade lucratively with other firms directly at higher prices. Producers want to secure suppliers through government channels at lower costs. Managers also need to cultivate guanxi with bureaucrats in order to protect the firm against the uncertainty of an environment in which legal safeguards are lacking. Managers of privately and collectively owned enterprises and foreign investment ventures have even stronger incentives to do this than those in state-owned companies because they have more difficulties getting preferential treatment from the government and are more vulnerable to the uncertain environment because of the liabilities of newness and smallness. This is consistent with the resource dependence model in that networks increase the external legitimacy of a firm, thus increasing its chance for survival (Pfeffer and Salancik, 1978). Economic sociology emphasizes that social trust can institutionally undergird market activities. Social trust refers to expectations of future interpersonal ties. It heightens expectations of stability in exchange because

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the transacting partners already know each other. The personal relationship also establishes a link for the flow of information on resource supply and demand. Social trust operates through cognitive and normative processes. Cognitive embeddedness refers to the mental frameworks that shape individual reasoning processes. Complex reality is rendered as familiar patterns, reducing time spent in reflection before deciding on an appropriate action. Normative embeddedness refers to the sanctioning of behavior via norms that are widely diffused in a population. Diffusion creates reasonable expectations that others will also behave in fairly predictable ways (Wank, 1996). For example, the Monarch Headgear company still invites its distributors to visit them in line with the old system. Where Western sales people would call on the customer for half an hour, Wang’s distributors spend serious time in Tianjin. Most travel far to get there; that too, is a factor in the relationships Wang builds with them. The suggestion that the company should visit the marketplace to solicit orders was met with incredulity. Because of guanxi, managers know that distributors will phone or fax for more stock if they need it. Guanxi ties are a form of social trust in a context of power asymmetry. Although clients are generally more dependent on their patrons, patrons are also dependent on clients because of the specificity of their ties. The trust built up in one linkage is not readily transferred to another party. This enhances the likelihood of future cooperation and an orientation toward mutual benefit. Therefore, trust, like property rights, is productive. By enabling parties to calculate risks and likely returns, it encourages business activities that would otherwise be less forthcoming. Guanxi can help reduce political uncertainty and thereby encourage investment and diversification out of speculative trade into service and manufacturing ventures. Central state policies can change suddenly, condemning practices that were previously permitted. Other uncertainties stem from changes in provincial and city-level policies. For instance, in order to protect local manufacturers and markets, provincial governments often suddenly impose tariffs on out-of-province products. Actions by local government also cause uncertainty as bureaus and individual officials use their control to gain a profit by levying fines, fees, and taxes regardless of standard procedures.

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Guanxi also spurs the development of new market channels, such as links with the bureaucracy, in order to obtain officially mediated resources that enhance profit and protection. Through these links, entrepreneurs find out about forthcoming changes in state policies and the likely interpretations of them locally, as well as regulatory actions directed against particular entrepreneurs. With such information, an entrepreneur can work out ways of coping. Another sort of channel is the development of new market links. One of the legacies of the planned economy is vertical channels which emphasize information flow between the center and periphery locations. Consequently, linkages between market sections can be weak. This was particularly true early in economic reform. Through guanxi, managers can obtain information on new market sources and outlets. This supports the state strategy of freezing state allocation quotas to encourage newly marketized ventures to procure resources and income. Figure 2.1 schematically highlights the economic benefits of guanxi development in a morally healthy society.

Morally Healthy and Normatively Legitimate Guanxi

Value-Added Social Capital

Reducing: 1. Transaction Costs 2. Operation Uncertainty 3. Information Costs 4. Contextual Hazards 5. Competitive Threats

Enhancing: 1. Institutional Support 2. Economic Return 3. Business Effectiveness 4. Organizational Legitimacy 5. Strategic Capability

Figure 2.1. Economic benefits of guanxi.

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Economic Idiom Managers classify guanxi capital by the principle of efficacy. Efficacy refers to the degree of benefit that an entrepreneur expects to derive from a relationship relative to the costs of cultivating it. It is judged in several ways, each expressed in a characteristic idiom (Wank, 1996). The first idiom is the unconditionality of support that can be claimed. In time of urgent need, a partner may need bureaucratic support without being able to offer immediate compensation to the relevant official. The greater the unconditionality, the more likely that reciprocity can be deferred. A second idiom is the degree of discretionary power wielded by a patron. Greater discretionary power stems from having a higher bureaucratic position; high ranking patrons are said to be harder to cultivate than lower ranking ones. Difficulty in establishing a tie with a higher official is still worthwhile, though, because such a link provides more benefits than lower ones because of the greater discretionary control over a wider range of public resources. A third idiom is connectivity, the extent to which a patron links one party to others in the bureaucracy. Connectivity is efficacious because a tie with one official can give the party access to the official’s guanxi with others. This reduces the costs to the party of cultivating each ties with each partner from scratch. A fourth idiom is obligation. Obligation stems from consanguinity; the thicker the blood, the deeper the obligations. The strongest obligations are endowed guanxi capital that is ascriptive and produced at birth. It exists between directly related kin, such as parents and offspring, brothers, and cousins on the father’s side. Weaker guanxi, accumulated through life experience, is called guanxi savings. Savings are personal ties formed prior to one’s business career that can later be used for commercial purposes. They involve emotional attachments created by shared childhood experiences. The weakest obligations are found in guanxi investments. These are personal ties forged after the onset of business, mainly for commercial ends. In sum, it is clear that guanxi is fundamental to Chinese economic transactions. Although profit-making is the main motivating force directing a business, economic actions are also embedded in larger social relations

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which influence business decisions. At the same time, guanxi cannot be understood merely as a cultural concept. In an environment of ongoing uncertainty, guanxi makes real economic sense, especially at the level of practice.

2.2 GUANXI VERSUS WESTERN NETWORKS Relationship development or networking building between organizations is critical to corporate success everywhere in the world. In recent years, Western management literature has increasingly analyzed the management of networks as an important aspect of strategic behavior. The network paradigm is seen as a means of understanding the totality of relationships amongst firms engaged in production, distribution, and the uses of goods and services. Networking can enhance a firm’s competitive advantage by providing access to the resources of other network members. It is particularly important with respect to entering a market that requires a firm’s core technologies and competencies. In addition, networking can bridge the gap between business people of different nations and cultures, hence stimulating trade that might not otherwise take place. Guanxi includes all of the above Western qualities, along with uniquely Chinese ones. Both concepts emphasize that networks are not discrete events, concerning self-liquidating transactions, but are continuous relationships. Continuity means that activities undertaken by parties in a relationship cannot be completed without the active and reciprocal involvement of all parties. However, as stated earlier, favor exchanges that take place amongst members of a guanxi network are not solely commercial. They are also social, involving the exchange of renqing (social or humanized obligation) and the giving of mianzi (“face” or social status). Guanxi is social capital, in contrast with networking in the West that mainly concerns commercialbased, corporation-to-corporation relations. Because of this difference, many Western business people overemphasize the gift-giving and wining-and-dining components of a guanxi relationship, thereby coming dangerously close to crass bribery or being perceived as only “meat and wine” friends. Guanxi is an investment in a relationship; it is not simply a “fee-for-service.” Guanxi

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strengthens personal relationships which may or may not be called upon in the future. Moreover, when assessing the other organization’s endeavor in developing a relationship with them, Western companies tend to emphasize their partner’s commitment to the overall market of which they are part of (market commitment), commitment to them as individual customers (customer commitment), the perceived adaptability of the partner, and the perceived distance between them. By contrast, firms that belong to the same Chinese guanxi network attach the utmost importance to one another’s long-term commitment and particularly to the social status of key managers, though firms in the web may actually contribute to one another unequally. Finally, guanxi is essentially personal, not corporate, relations. Whereas Western networking focuses on organizational commitment in the assessment of a partner firm’s effort to develop the relationship, guanxi emphasizes personal relationship creation and development. When a personal relationship is used by the organization, then guanxi plays a role at the organizational level. This difference underlies the idiosyncrasies of Chinese and Western network building. Firms in Chinese society build the relationship first; if successful, transactions will follow. Western businesses build transactions first; if successful, a relationship will follow. Continual network building is important to guanxi relations. The Chinese believe that networking may enhance a company’s competitive position by providing improved access to the resources of new network partners. An improved network is insurance that some members of the network will have the influence to offset a future problem related to doing business within China’s weak institutional and legal environment. Chinese businesspersons target desirable potential members and create linkages using intermediaries as part of the tactic of network building. Goal congruity or compatibility is important to networking success in the Western countries. This compatibility is viewed as a necessary condition underlying network formation because it determines both the strategic and organizational fit between firms. Although understanding each other’s goals and interests is important in Chinese guanxi, goal congruity or compatibility is not a prerequisite for building and sustaining a good guanxi network. Two firms with totally different strategic goals in different industries may maintain excellent guanxi through favor exchanges such as introducing

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key governmental officials to each other or providing corporate loans to a party which has liquidity difficulties. In sum, Chinese guanxi is a network based on favor exchange in which nothing is specified and interests are not necessarily mutual. By contrast, Western networking is based on benefit exchange in which each party’s commitment, contributions, and obligations are stipulated and the strategic goals of the relevant parties are compatible. Resource complementarity is crucial to network success in Western economies, as it affects interpartner fit and synergy creation. Chinese guanxi shares the importance of this complementarity, although such resources originate from individuals and can be any favors beyond technological, strategic, organizational, and financial competencies. As guanxi is reciprocal, if one returns a favor which is precisely what the partner wants, this guanxi is strengthened and will become more solid and profitable. While the recipients of past benefits may choose at their own discretion to provide less costly or less complementary returns, the person receiving the return favor is the one that judges its appropriateness and favorability. Providing an unfavorable or inappropriate return may result in loss of face within the community. Guanxi partners attempt to avoid this prospect by attempting to determine each other’s expectations and calculating responses that will facilitate a mutually supportive environment. In addition, the giver of a benefit must evaluate his or her position in relation to the recipient. A weaker guanxi party is expected to receive a better return than would the stronger party as a matter of equity. The expectation of an appropriate return, combined with sanctions against inappropriate returns, suggests that guanxi partners must be actively concerned with understanding and helping each other accomplish goals by providing complementary resources and assistance.

2.3 GUANXI AS A CRITICAL CAPABILITY Critical capability can be defined as a firm’s business and organizational competency. Economic rent is created when the business, organizational, and technological process skills of a firm are enhanced by or interwoven with key industrial properties. In a society where relational and ethical norms are held, legitimate guanxi may serve as a critical capability in the following ways.

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Guanxi is value-created human resource which improves a firm’s organizational capabilities. Firm capabilities are developed from diverse cultural traditions which create different administrative heritages among firms from different nations, regions, or industries. As a distinctive, valuable resource, guanxi can improve firm performance. Although guanxi connections are not rare in Chinese organizations, each guanxi differs from all others. Even within the same organization, different guanxi relations vary in terms of firmness, reciprocity, sustainability, partners, and favorability. Thus, each guanxi relationship is individually embedded and constitutes tacit knowledge or a distinctive resource. During the period when an individual possessing unique guanxi works in a particular organization, his or her guanxi will become organizationally embedded. Guanxi is also a rent-yielding strategic asset, stimulating a firm’s strategic capabilities. A company possessing better guanxi connections with the business community and governmental authorities can gain an edge over its competitors. Networking with other players in the business community affects value creation as well as profit margin. Relationships with various governmental agencies are also critical to gaining a competitive advantage. Governmental regulations, particularly industrial policies, significantly affect the degree of competition among firms, financial and operational treatment received from governmental authorities, and the assistance offered by the government. A good relationship with the government usually enhances a firm’s market and financial performance. This may be achieved through superior distribution channels, priority access to scarce resources and the infrastructure, and direct or indirect subsidies provided by the government. Valuable and rare guanxi that enables a firm to earn superior profits in China will create strong incentives for imitation. A firm’s competitors may try to develop guanxi with that firm’s guanxi partners. Such efforts must take into account the time-compression diseconomies factor. This factor operates as a law of diminishing returns when time, as an input, is held constant. Over a particular time interval, the quality of guanxi that can be developed is unlikely to be directly proportional to the efforts invested in cultivating it. Establishing a social guanxi base may be easy, but it takes time to develop ganqing, which is the key determinant of the guanxi quality. A one-year relationship is hardly comparable to a ten-year one.

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For the Chinese, an old friend is different from just a friend. Thus, foreign companies that have been in China for a long time are likely to enjoy an edge over their competitors. A case in point is the Hong Kong and Shanghai Banking Corporation which maintained its branch in Shanghai even after the communists took over the city. Another barrier to imitation is the intricacy of interpersonal chemistry, which makes guanxi a socially complex resource. The ambiguity about exactly how to accumulate guanxi makes it very difficult to identify, let alone control all the key factors that contribute to establishing and nurturing good social guanxi. A further factor is a partner’s guanxi capacity. Social interaction is crucial not only to the development of close guanxi, but to its maintenance. Without social interaction, ganqing withers and guanxi becomes more distant. The constraints of time, money, and effort set a practical limit on how much close guanxi any individual can develop and maintain. A businessman engaged in trade with China mentioned that in certain booming Chinese cities, some senior officials were too busy to entertain new potential investors, further illustrating the advantage held by long-time partners. Another form of imitation occurs when a firm’s competitors try to develop guanxi with parties similar to, or even stronger than, the firm’s partners. When companies with a similar set of guanxi compete to sell to the same end-user, for example, the strength of their guanxi will be put to the test. A key factor affecting the success of a firm’s imitation strategy is its ability to develop guanxi. The resource-based theory concept of asset mass efficiency argues that success breeds success. Historical success translates into a favorable initial stock resource position, which in turn facilitates further resource accumulation. A simple example is that a firm’s existing stock of R&D know-how is an important determinant of its chance of making further breakthroughs and new discoveries. Similarly, existing guanxi facilitates the creation of new guanxi. It is much easier for a person with lots of face to initiate new guanxi. Certain guanxi is rare and difficult to imitate. Nevertheless, even if a firm has valuable guanxi that is not imitable, its competitive advantage may not be sustainable. The reason is that guanxi, if possessed by an employee, is mobile. An assumption of resource-based theory is that strategic resources may not be perfectly mobile across films. The nature of guanxi, to some

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extent, violates this assumption. One way to reduce the mobility of guanxi is to convert interpersonal guanxi into interorganizational guanxi. As a critical capability, guanxi requires continuous investment. Guanxi capital investments are made in two ways. One is through the business process itself. Through repeat exchanges, trust builds up between two individuals, enhancing the possibility of cooperation. For example, a textile store operator made repeated sales to a purchasing agent from a Shanghai department store. To ensure that the agent did not buy from his competitors, the entrepreneur gave him personal presents of clothes. When the entrepreneur wanted to set up a business in Shanghai, he leaned on the agent for an introduction to a store manager in order to set up a joint venture boutique with the department store. He subsequently ingratiated himself with the manager so he could use the manager’s networks to set up a night-club in Shanghai. The buildup of trust is essential for more profitable but illicit exchanges. In dealing with public purchasing agents, an entrepreneur might proffer an expensive bottle of wine so as to judge the agent’s willingness to accept extraordinary rewards. Eager acceptance indicates the agent’s likely reception of an offer of kickbacks in exchange for placing large orders. An example concerns an entrepreneur who was introduced to a high cadre official from an inland industrial city. This official contracted with the entrepreneur to buy home appliances for distribution as bonuses to public employees. When delivering the appliances, the entrepreneur included a free television for the cadre official. The relationship progressed to the point where the cadre sold restricted materials such as metal pipes and raw materials to the entrepreneur. A variant of trust engendered through the business process involves entrepreneurial run-ins with administrative cadres. In one instance, an entrepreneur was charged with bribing a high official during a clean government (lianzheng ) campaign. Brought in for repeat interrogations by the investigating agency, he was eventually cleared of all charges. Shortly afterwards, when the city government sought to contract out a public bus company, the investigating agency recommended the entrepreneur as the leasee and he got the contract. It seems that he had developed personal relationships with individuals in the agency during the investigation. The second way guanxi capital investments are made is by participation in associations that have been revived or newly founded during the

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reform era. These can be business associations such as the Individual Laborers’ Association, Metropolitan Chamber of Commerce, the Young Factory Director and Manager Association, the Artist and Entrepreneur Association, and associations for overseas Chinese. Guanxi investment can be aimed at securing favorable discretion regarding resources controlled by the association’s sponsoring public agency. Investments made by participation in an association also seek to enhance connectivity beyond the association’s boundaries. The optimizing strategy of guanxi investment seeks to enhance the strength and durability of bureaucratic support. Enhancing strength involves investing in relationships with certain officials as a springboard to forging ties with higher level officials. This is the classic strategy for entrepreneurs from low social backgrounds who lack guanxi endowments or savings when they begin their business careers. The growth of several prominent private firms can be understood as a step-like sequence as their operators “trade up” to higher levels of bureaucracy to gain better profit and protection opportunities by piling investment upon investment. Optimizing strategies also seek to enhance the guanxi’s open-endedness. The quid pro quo exchange of guanxi investments precludes more spontaneous support from officials. Yet the need for such support grows as wealth accumulates. To enhance open-endedness, emotional affect can be added to an investment. This increases trust, giving an official greater assurance of being awarded later for services rendered, without the necessity of prior negotiations for remuneration. Emotional affect is imparted to an investment in several ways. In gift-giving, an entrepreneur proffers material rewards without explicitly demanding a return. This represents reciprocity as a disinterested rather than instrumental quid pro quo exchange. It gives the entrepreneur a chit in the form of the cadre’s feeling of gratitude that can be reclaimed in future support. Even money can be given as a gift. Large amounts stuffed in the red envelopes that customarily contain coins given to children during the Spring Festival are offered to officials for their children’s education. Cash can be given to an official as a token of gratitude for artfully painting his or her signature with a calligraphy brush.

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Favors (renqing) differ subtly from gifts because they involve nonmaterial exchanges and suggest entrepreneurial disinterest in calculated reciprocity. Whereas gift-giving induces obligation through gratitude, favors induce more genuine warmth (renqing) and concern (guan xin ). Furthermore, while gifts are often little more than an entrepreneur’s response to a cadre’s hinted demands, a favor depends on the entrepreneur’s shrewd observation of a cadre’s unarticulated needs. For example, one entrepreneur counselled a young official on marriage and introduced him to prospective mates. Another who travels often by chauffeured car to other cities gives lifts to officials so that they can visit their families, friends, and colleagues. Upon arrival, these officials often introduce the entrepreneur to their colleagues, enhancing connectivity. Banqueting also imparts affect to interest-based guanxi capital. Many larger private companies own restaurants so they can discreetly wine and dine officials, not to mention keep down entertainment expenses. These restaurants are ornately decorated and serve delicacies such as rare fish and game; the repast’s sumptuousness further obligates the officials. Banqueting is especially active during Spring Festival, year-end business parties, and the Mid-Autumn Festival ( ) in the summer. Entrepreneurs also enhance obligation by letting officials use their restaurants at a discount for personal occasions. One official held his daughter’s wedding party in an entrepreneur’s ornate restaurant, which doubly obligated him because he received both a steep price discount and “face” (mianzi) from the party’s lavish setting. Finally, cadres can be wined and dined in more personal circumstances with invitations to an entrepreneur’s home or the wedding party of an entrepreneur’s child. Over time, optimizing strategies can alter instrumental guanxi investment to include the intimacy of guanxi capital savings.

2.4 BUSINESS IMPLICATIONS International academic and popular interest in the economic development of Chinese societies has recently been given a powerful impetus by a concatenation of events. The first is the adoption of an open-door policy

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and economy, political turmoil, and self-imposed isolation. The World Bank expects China to become the world’s largest economy in the early next century if it maintains its current rate of growth. The second is the phenomenal success of the market economies of Hong Kong, Singapore, and Taiwan. The third is renewed scholarly interest in the Confucian ethic as a possible driving force behind newly industrializing Asian countries, in much the same way as the Protestant ethic contributed to the industrialization of Western Europe and North America. The emergence of greater China as a global economic power has drawn the attention of management scholars who have come to see this territory as one of the last frontiers in management research. In recent years, firms in greater China, including both local and foreign businesses, are re-engineering and restructuring their organization in an effort to pursue realistic business or investment strategies and to accommodate firms’ strengths and weaknesses within the peculiar environment. Indeed it has long been recognized that doing business in this environment is particularly difficult and that a key difference between Chinese and Western business practices lies in the utmost importance of guanxi in the former, as opposed to the specification and enforcement of contracts in the latter. Chinese and Western business people approach a new relationship from opposite ends. A Western business person starts with a standard contract, alters it to fit specific circumstances, and signs the revised version as a matter of course. Commercial law is ingrained in Western thinking. Contract law grew up in 18th century Europe to give traders reasonable assurance that deals would be honored. Relationships were weak and legal sanctions were required to ensure obligations were met. Whilst Chinese authorities recognize the need to develop contract law, largely to meet Western expectations or perhaps the lack of satisfactory relationships between Chinese and foreigners, few traders can yet rely on it. Traditionally in China, commercial law barely existed; use of it usually indicated bad faith. While business clauses might form a useful agenda, obligations come from relationships. The early appearance of a draft legal contract was seen as inappropriate or, more likely, irrelevant: it carried no sense of commitment. Thus, returning home with a signed piece of paper is a symbol of progress but no more than that. The Chinese, who would once have been immensely puzzled by the need for the

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contract, may be doing no more than humoring honored guests. From this perspective, it is not strange that McDonald’s was evicted from a central Beijing building after two years despite having a 20-year contract, simply because an incomer from Hong Kong had strong guanxi with the government whereas McDonald’s had not kept its own in good repair. Guanxi therefore provides a complement to contract law. So long as the relationship is more valuable than the transaction, it is logical to honor the transaction. Both parties therefore need to keep regular tabs on the state of their relationship. Detailed problems will work themselves out so long as the relationship, and that means long-term benefits for both, is positive. The commercial legal system can be seen as a counterpart of guanxi: the presence of one reduces the need for the other. Taken together, the trader has protection whichever is weak, provided the other is strong. It seems that the high impact of guanxi on firm performance is unabated over time. In China’s new, fast-paced business environment, guanxi retains its prominent position. Yeung and Tung (1996) report recent survey results concerning the business importance of guanxi. The respondents (top executives in foreign-invested enterprises in China) were presented with a list of 11 factors and asked to rank them in order of importance to longterm business success in China. They were (1) choosing the right business location; (2) choosing the right entry strategy; (3) competitive prices; (4) complementarity of goals; (5) familiarity with Chinese negotiation style; (6) flexibility in business operations; (7) guanxi with Chinese business associates; (8) long-term commitment to the China market; (9) management control; (10) product differentiation; and (11) quality. Amongst these factors, guanxi was the only item which was consistently chosen as a key success factor. Respondents attributed the importance of guanxi to the ambiguity of Chinese legislation. In the absence of explicit guidelines, directives and policies are open to interpretation by those who occupy positions of authority and power. It is clear that the Chinese market cannot be effectively tackled today without paying attention to the construction and maintenance of good guanxi. Guanxi, or the relational paradigm, is not only at the forefront of Chinese marketing thinking but is seen as a competitive advantage which the Chinese are in no hurry to explain. It affects the everyday life of every marketer.

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A country that has only just moved from a six to a five and a half day week places less emphasis on the separation of social, or private, life from business, which is in any case recreation compared to the old planning and production system. Thus, the involvement entailed by guanxi is more personal than corporate, and not limited to business hours. The emergence of Western- style managers with MBAs, increased job hopping, more discretionary spending and time available for family and leisure activities, will erode the paradigm to some extent but not eliminate its pre-eminent position. Business transactions with Chinese individuals and organizations need to be approached with the knowledge that the Chinese will place them in the context of their own guanxi networks, which may require meeting obligations of individuals who have no direct involvement in the matter at hand. In China’s collectivist culture, the “real” decision-maker may be the network as a whole, not some mysterious and unseen individual. It is suggested that Western investors and marketers themselves need to establish their own guanxi, which requires looking beyond the transaction at hand to its implications for the development of personal relationships. In general, a business person can demonstrate the good faith that forms the basis for a gradual transition from outsider to insider by bestowing favor and face through considerate and sensitive giving of minor gifts, hosting appropriate dinners, and, more importantly, giving personal attention. It is also imperative for Chinese domestic firms to make a good coupling between the conventional wisdom of guanxi and modern management philosophies introduced from the West following the continuous opening up of the Chinese economy. In China as elsewhere, product and price must be right. The art of marketing lies in adding value which makes a difference when products and prices are similar with those of the competition. As more efficient production and distribution have reduced tangible variations worldwide, added value becomes more critical. The neo-classical perspective focuses on the amounts expended on advertising, packaging, or promotion and attempts to assess the resultant change in transactions. What it neglects, however, is the added value guanxi brings to transactions. Guanxi investments are made in recognition that the lifetime value of a well-treated customer and his or her good opinion far exceed any single transactional benefit.

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Of course, there are many businesses in China, as elsewhere, where relationships are not seen as valuable. Service is still non-existent in many shops. Counter staff enjoy each other’s company too much to make time for waiting customers. Market vendors may not expect to see individual customers again. Where there is no guanxi, people are treated as though almost invisible. For example, many electronic products are either smuggled into China, brought in on the grey market, or counterfeited. Manufacturers cannot offer the backup service one might expect in the West. If end-users want after-sales service, they will have to establish guanxi with the retailer. Guanxi pervades the business world in all Chinese societies. With nearly one quarter of the world’s population and one of the fastest rates of economic growth, greater China today is attracting the attention of practitioners and academics alike. Indeed, for many generations, emigrant Chinese entrepreneurs in Taiwan, Hong Kong, and Southeast Asia have been operating comfortably in a network of clan and family, laying the foundations for stronger links among businesses across national borders. Guanxi connects overseas Chinese in a meaningful way; it constitutes an instrument used in the aggressive, entrepreneurial pursuit of regional wealth. If many Chinese with guanxi enter an economy, that economy can be a world player as the power of the firms’ networking abilities allows them to transcend the limits of individual firms.

2.5 T  HE USE OF GUANXI BY OVERSEAS CHINESE BUSINESSES Foreign direct investment (FDI) in China originates primarily from two sources: Chinese community investors and Western multinationals. Although more than 40 countries from all over the world have directly invested in China, about half of the total FDI in the country has come from the Chinese community — namely, Hong Kong, Macao, Taiwan, and Singapore. The aim of this section is to illuminate how guanxi, along with some other factors, has contributed to such investment dominance.

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Economic Perspectives Competence complementarity: The fundamental driving force behind cross-border cooperation is economic self-interest, resulting from the exploitation of market potential or complementary resources, abilities, and skills. Although Chinese investors may not have the competitive advantages of advanced technology, which constitutes a scarce competency necessary for the modernization of China’s economy, they greatly assist the commercialization of mainland Chinese research and inventions. A major strength of the Chinese technological system is the vast number of highly trained scientists performing quality basic and applied research. According to government data, China has 400 000 employees working in 15 000 nongovernmental scientific research institutions, as well as unspecified thousands working in more than 5000 state-owned R&D institutions and 1000 tertiary educational institutions. Unfortunately, research results are rarely successfully commercialized or brought to the global market. Taiwan, Singapore, and Hong Kong can play an important role in this part of the innovation process. In recent years, Taiwanese firms have emerged as capable competitors and leaders in the production and design of quality consumer electronics, computers, memory chips, and microprocessors. Expertise in these areas, while initially acquired through technology transfer, was followed by a sustained effort to modify, develop, and produce these products domestically. Taiwanese firms have also cultivated extensive technological linkages with other leading companies, particularly in the United States, so as to continue having a source of transferable technology. The Taiwanese have studied abroad and worked in prominent firms, then returned home bringing with them a wealth of professional and technical expertise and business contacts. Hence, Taiwan has gained sound development and design capabilities through its own domestic efforts as well as from returning professionals. Through its export success, the island has also accumulated substantial foreign exchange reserves, facilitating an increase in wage and other factor costs. As a result, Taiwan has become relatively strong in terms of development and design capabilities, capital, and linkages to the world’s technical and business communities.

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Hong Kong is renowned in the world as a commercial and financial center. Since being founded as a trade entrepôt over a century ago, this naturally resource-poor territory has relied upon trade and sales know-how to survive. It has capitalized on its strategic location, ample harbor, and supportive governmental policies to become a worldwide commercial port. Post-war industrialization, the transition to a service and financial center, and subsequent maturation of Hong Kong’s domestic market have further developed its financial networks, infrastructure, and capabilities. Today, despite political uncertainty, Hong Kong serves regional executives in the areas of finance, telecommunications, transport, and shipping. Its businesses buy, sell, and market goods to all parts of the world, while serving the needs of the emerging Chinese market in particular. As China’s economic reforms deepen, Hong Kong once again serves as an important entry point for many international firms seeking to do business with China. Singapore is another resource-poor country; however, a strategic location along international shipping and air routes combined with welltrained and resourceful manpower, sound management skills, and a supportive external environment have led to dynamic growth and a robust economy. This has resulted in superior Singapore–MNC partnerships, as it provides an international gateway for products manufactured by FDI projects established in China. While Singapore is in need of raw materials and a source of inexpensive products and offshore manufacturing, China needs manufactured products, machinery, advanced technical expertise, and management skills. Thus, Singapore finds itself in the enviable position of being able to offer strategic alliances to international companies seeking a base from which to launch and manage investment projects in China. In addition, investors originating in Singapore can also tap the Southeast Asian market. This is of increasing importance as China pursues global market diversification in an effort to reduce its dependence on the markets of the United States and Japan. Moreover, Singapore, a country of 2.7 million people, has foreign exchange reserves exceeding US$34 billion. As one of the largest financial centers in the Asia and Pacific region, Singapore investors are able to provide abundant capital resources for upcoming investment projects in China.

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The preceding section suggests that these three Chinese economies have different capabilities related to innovation. They could benefit by pooling complementary capabilities and manufacturing their products at mainland investment sites, driven either by a technology-push or a market-pull process. In a market-pull process, starting from the downstream-market end, Hong Kong and Taiwanese firms would identify a particular market need, design a product to fit the demand, raise the necessary capital, and produce it on the mainland. The finished goods would be shipped through the port of Hong Kong into international markets. China’s researchers would provide technical input into product design and production. In a technology-push process, thousands of researchers in China would discover ideas for numerous potential products and processes. Taiwan’s experts would utilize their Western education and experience to guide the development and design processes, transforming the most promising findings into products capable of meeting market needs. With relatively low labor and production costs, China’s business enterprises would then take the product specifications and produce technology-based, market-oriented goods in a cost-competitive manner. These products would then be marketed, distributed, and sold, to a large degree, by the business communities of Hong Kong and Singapore. The entire process would be fuelled by capital from Hong Kong’s numerous financial institutions and technological expertise from Taiwan. Market demand similarity: Apart from the market opportunities that are commonly available to all international investors, the dominance of Chinese community investment on the mainland is also attributable to the similarities in demand conditions, consumer utility functions, and consumers’ social and cultural backgrounds between the host and home markets. The rationale behind this location pattern is consistent with Linder’s model of international economics which posits that the more similar the demand preferences for manufactured goods in two countries, the more intensive will be the trade and investment between them. It is apparent that investors from the Chinese community are unlikely to possess the sort of firm-specific advantages on which the power of Western multinationals is based, namely a monopoly over technical knowledge. Similarly, a lack of sufficient market power makes it difficult to sell differentiated brand goods worldwide. Chinese community investors make direct investments in China by committing and contributing unique distinctive competencies, including technologies appropriate to the

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local environment such as factor costs, input characteristics, demand level, and consumption sophistication. The industrial life cycle hypothesis in the FDI literature suggests that the vigor of FDI is contingent on differentials in the industrial or product life cycle phase between home and host countries. It is evident that industrial products and production processes from Taiwan, Hong Kong, and Singapore are currently being passed on to the mainland. The result is an increasing extent of intra-regional FDI in the country. The division of labor in industrial production is both horizontal and vertical, resulting in increased volume of intra-regional trade, increasing importance of FDI in technology transfer, and the transmission of industrial production from the layer of countries at one stage to those next in line. Although greater China countries are adopting an export-oriented strategy, the degree of complementarity is in fact greater than the extent of competition. Members of this community specialize in production processes according to changing comparative advantages. FDI has served to facilitate the development of specialization within the region. Geographic affinity: It is apparent that geographic affinity is an important contributor to the phenomenal growth of FDI by Chinese community investors. Hong Kong and Macao are adjacent to Shenzhen and Zhuhai, two of the first four of China’s special economic zones opened in 1979. Similarly, Taiwan is just opposite Xiamen, another special economic zone located in the Fujian province. Although Singapore is not as close to China as Hong Kong and Taiwan, it enjoys strong geographic advantages, not only due to its proximity to the mainland but also because of its international air and sea routes which straddle the time zones of Asia and Europe. It is at the heart of the economically dynamic Asia- Pacific region. For Chinese community investors, these geographic advantages reduce transportation costs and turnaround time for mainland production, obviously crucial in vertically integrated manufacturing. The opening up of China coincided with the emergence of severe labor shortages in Hong Kong, Singapore, and Taiwan and the need for restructuring within these three economies. There has been a large-scale movement of export-oriented, labor-intensive industry from Chinese community territories, particularly Hong Kong, to mainland coastal areas such as Guangdong, Fujian, Jiangsu, and Zhejiang. In addition, although international investors

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from Hong Kong, Taiwan, Singapore, and Macao are the major source of FDI in China, in a broad sense, they are moving relatively labor-intensive activities into China in an attempt to escape rising labor costs and space constraints at home. Many Chinese community investors, particularly those from Hong Kong and Taiwan, have been operating in the same labor-intensive industries such as textiles, garments, electronics, electrical goods, metal, plastics, and toys — most have mature technologies which comprise most of their prior exports. As the tightening labor market raised wage costs in their home territories and economic expansion made factory sites more and more expensive, moving production to China, where wage levels are fundamentally lower, becomes immensely attractive. Chinese community businesses investing in capital-intensive or technology-intensive industries could also attain the benefits of cost minimization in the Chinese manufacturing sites. In addition to the labor cost concern, investors can acquire raw materials, semi-completed products, parts of machinery, components of equipment, and even patents at a price considerably lower than in the home market. As a result, lower direct costs of manufacturing as a result of shifting production sites to the mainland helps enhance international competitiveness.

Cultural Perspective Ethnic ties: In addition to economic concerns, China’s ability to attract Chinese community investors resides in ethnic ties. This can be seen from the fact that the incentives offered by the Chinese government are quite comparable to those offered by neighboring economies such as Indonesia and Malaysia, but international investors from greater China area have undertaken much more outward investment in China than in Indonesia or Malaysia. Contacts between China and the rest of Southeast Asia have a very long history dating back to before the Han Dynasty (third century B.C.). There are at least 20 million ethnic Chinese living in three Indo-Chinese states, six ASEAN states, and Myanmar. However, the only state in Southeast Asia in which the Chinese are statistically dominant is Singapore. Since Stamford Raffles of the British East India Company established the colony as a free trading port, Chinese, Indians, British, Arabs, and others

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went to Singapore in increasingly large numbers to take advantage of the economic opportunities there. By 1836, the Chinese numbered 13 700 and had overtaken the indigenous Malays, who numbered only 12 500 by then. The Chinese became the majority in 1849, forming about 53 percent of the total population. Today, 78 percent of the population is Chinese, numbering about 2.2 million, all having language, cultural, and family ties with China. Historically and culturally, Taiwan and Hong Kong have been an integral part of the mainland and there are no obvious cultural differences existing between them and their ancestral land. Ethnic ties have been a major influence on Chinese community-funded FDI in mainland China. There is striking evidence supporting this point: since 1985 when the Pearl River Delta (in Guangdong), the Minnan Delta (in Fujian), and Hainan Island were designated as the three largest open regions able to offer investment incentives similar to those of the 14 open coastal cities and four special economic zones, the pattern of investment has appeared in a fashion consistent with ethnic tie distributions. Specifically, investors from Hong Kong and Macao, most of them from Guangdong and Cantonese-speaking, have been focusing their investments on the Pearl River Delta. During the period from 1979 to 1993, the Pearl River Delta received one third of cumulative utilized FDI in China, while Hong Kong accounted for over 80 percent of this flow. Guangdong was thus the destination of over 40 percent of Hong Kong’s FDI in the mainland. Similarly, their counterparts from Taiwan, most of them originating from Fujian with Minnan dialect, have been more actively engaging in the Minnan Delta. At the same time, Singapore investment projects are heavily located in Guandong, Fujian, and Hainan Island; this characteristic conforms with the ethnic feature in Singapore where 94 percent of Singapore Chinese came from Guangdong, Fujian, and Hainan Island. It is clear that ethnic relations have played an important role in spurring the Chinese community’s investment in the mainland and distributing the pattern of location of investment in the country. One economic rationale behind the ethnic effect lies in the consideration of information and learning cost. Indeed, the cost of acquiring reliable information about foreign markets is large, and it is likely to seem particularly burdensome for the smaller international firms in developing countries. If someone trusted by the manager resides in the potential market, the cost of acquiring credible

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information is likely to be much lower than if the home office must send its personnel abroad to study opportunities. In most cases, the initiatives for Chinese community businesses come from relatives or business associates in mainland China. With knowledge of the local market and access to a distribution system, these associates seek out foreign investors whom they know and trust. The role of ethnic ties also manifests itself in the partners chosen for the equity or contractual joint ventures in China. Many mainland-Chinese community partnerships are built upon between the same ethnically-related parties. Guanxi networking: Another important cultural factor fostering Chinese community investment in the mainland has to do with guanxi, a concept which is somewhat related to ethnic ties. Its importance in the success of Chinese community is commonly highlighted in the Chinese management literature. The Chinese word guanxi refers to the concept of drawing on connections or networks in order to secure favors in personal or business relations. Traditional Chinese society is built around clan-like networks, with close family members constituting its core. Loyalty to the in-group is paralleled by a deep distrust of non-members. It must be understood that the concept of “family” extends largely beyond its strictly biological meaning. It could be pictured as a set of concentric circles of contacts, typically stretching from close family, to slightly distant, to more distant, eventually embracing people who are not blood relatives but who are connected to someone in one’s family or relatives, such as classmates, people from the same region, friends, friend’s friends, and so on. The greater Chinese community encompasses an array of political and economic systems bound together by a shared tradition, not geography. For many generations, emigrant Chinese entrepreneurs have been operating comfortably in a network of guanxi, laying the foundations for stronger links among businesses across national borders. Not based in any one country or continent, this community is primarily a network of entrepreneurial relationships consisting of many individual enterprises that nonetheless share a common Chinese culture. This network is an interconnected yet potentially open system, and in many aspects, provides a new market mechanism for conducting global business. As a result, when Chinese-based economies such as Taiwan, Singapore, and Hong Kong have astonishingly large capital

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surpluses, financial resources will be deployed for new venture activities in these private and informal capital markets of Chinese family and clan associations without the intervention of commercial banks or government investment agencies. For instance, business links between Taiwan and mainland China were forged not through official channels but through guanxi networks or gray-market mechanisms. These peculiar advantages could contribute a variety of commercial privileges and a great deal of business potentials for the firm. Networking of guanxi extends much farther than mere ethnic ties. In recent years, many Chinese community investors have begun to locate FDI projects in regions other than Guangdong, Fujian, and Hainan. For instance, Hong Kong, Taiwan, and Singapore are all among the top five sources of FDI launched in Jiangsu province. It has been observed that the majority of local partners of joint ventures formed by Chinese community investors are their guanxi hu, or the organization in which the management has guanxi connections with the foreign investor. These local guanxi hu are usually local partners in previous business dealings such as import and export businesses, compensation trade, processing and assembly, international leasing, technology transfer, and other international business activities.

2.6 PRACTICAL EXAMPLES Minicase 1: Guanxi: The First Step in Any China Venture Dreams of making an easy fortune from the world’s most populous nation have lured many to China. A belief that doing business in China will be similar to home almost certainly guarantees their efforts will fail. Two Westerners with successful joint venture experience in China say the first step to avoiding that failure is to gain an understanding of guanxi. “Guanxi is everything; it is complete trust,” says Maureen Gain, a cattle breeder from Jerilderie in southern New South Wales. Alistair Britton and his wife Kitty Xu, who run a Hong Kong-based business consultancy, Emperor Dragon, define it as back-scratching, trust-building, and obligation. Britton, who has spent the past ten years setting up joint ventures in China, including one for General Motors, says it takes longer to develop a

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meaningful personal or commercial relationship in China because it takes time to build a platform of trust. “A Westerner says, ‘We’ve got a contract signed, let’s go;’ Chinese see a contract as the beginning of a relationship, not as something that has been achieved.” Gain and Britton advise to forget about quick profits. In September, Gain signed a 50-year agreement with the Beijing General Corporation of Agriculture, Industry and Commerce. The corporation, a diverse state-owned conglomerate with 220 000 employees, is involved in a range of activities, from running McDonald’s outlets to hotels, golf courses and taxi fleets. Gain’s company will help it establish a 12 500-head Romangna feedlot near Beijing. Gain says an important step in building trust with BAIC came in March 1995, immediately after she had returned from seeing corporation officials in China. With a packed business schedule in Australia, she received a call from a contact at BAIC asking whether she would go back to China for another meeting. “I spoke to the man who asked me and said, ‘I know you wouldn’t ask me to do this unless it was necessary,’ and he said, ‘Yes’.” Despite her staff calling her “crazy”, she flew back to China. She says this decision was crucial. Gain believes many Australians trying to do business in China are woefully unprepared. She spent 14 months and about US$300 000 studying the culture, the market for her product, and building contacts in Hong Kong before making her first trip to China. She studied Chinese history and culture and had private tuition on how to present in China. Gain says she learned certain basic social skills as part of her course. For example, body language and gestures that are innocuous here are less benign in China. Showing the palm of the hand is considered rude; maintaining direct eye contact causes social discomfort in China rather than conveying sincerity. Keeping “face” is absolutely vital, she says. “If someone has a stupid suggestion here, you just tell them to go and have another look at it. You can’t do that in China. There you have to say, ‘That’s a fantastic idea,’ talk about it for an hour and then make an alternative suggestion.”

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“Westerners don’t understand [the need for] the days of meetings over cigarettes and green tea. But to Chinese much has been done. As Chinese people become more comfortable with you, trust is established and the barriers and formalities break down.” Gain advises: “If you walk away from a meeting not sure of the result, it means the Chinese are not interested and don’t want to do it. However, if they want to proceed, you will know about it. If they tell you they will do something, they will do it.” Xu says Westerners should be aware that assertive individualism cuts no ice in China. “Society is more important than the individual. Proposals are assessed in terms of mutual advantage and mutual risk to the group concerned.” Britton and Gain emphasize that it takes considerable time and money to get established. Britton’s joint venture agreement for General Motors took eight years to conclude. Gain has spent about US$1 million so far and expects no returns for another two years. She says, “Forget about going in on a shoestring, it can’t be done.” Source: Adapted from Langford (1996).

Minicase 2: Business Connections by Big Six Accounting Firms Past performance, as they say, is not a guide to future returns. So it has been for accountants in China. The so-called “big six” firms that dominate the international accountancy business might have thought that their market shares in Hong Kong, fought out over decades among multinational firms headquarters there, would set the parameters for their performance in China. How wrong they would have been. Arthur Anderson, a minnow in Hong Kong, is the market leader in China with a current employee head count of around 400; more than half those employees are located in Shanghai, where Anderson strides ahead of the competition (though the gap is narrowing). Ernst & Young, a much bigger company in Hong Kong with 700 employees, has the brand equity of a discount soap bar and a head count of 180 on the mainland. Why should this be?

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The answer is that China is not Hong Kong and cannot, in a service industry such as accountancy, be run from Hong Kong. To some extent, strength in the British colony has been a handicap in China. Arthur Anderson, with a relatively young operation in the territory, never thought to enter the Chinese market from that base. China was assessed and strategized by Anderson’s worldwide partnership. The result was a bigger, quicker push than any of the company’s rivals. Anderson partners now talk about increasing their tiny market share in Hong Kong off the back of their China strength. Two other “big six” firms that are strong in Hong Kong have managed to stay strong on the mainland. Price Waterhouse established a presence and reputation in Beijing and Shanghai early; it then won a US$7.5m contract to work with the People’s Bank of China, the country’s central bank, to develop systems for due diligence and prudential supervision in the state banking system. The project will not earn Price Waterhouse much, if any, profit but it is a great relationship builder. Coopers & Lybrand (C&L), on which this article focuses, had no special tricks to build a China practice that will produce estimated 1996 revenues in excess of US$10m. But the company did make a good choice of partner and never underestimated market potential. C&L opened a representative office in Shanghai in 1981 and one in Beijing in 1986. The 1980s, however, were dull years for accountants in China. It was only after the Ministry of Finance decided to let accountancy firms conduct their full range of business — through mandatory 50:50 joint ventures — that the race for market share was on. This happened in 1992. Price Waterhouse and Deloitte Touche Tohmatsu teamed up with Chinese accountancy firms in Shanghai. C&L’s other three major competitors all chose accountancy companies directly under the Ministry of Finance. C&L was to some extent the odd one out, because it chose as its partner China International Economic Consultants (CIEC), a unit of China International Trust and Investment Corporation (CITIC), the investment arm of the State Council. CIEC did have a small accountancy subsidiary, most of which it put into the new joint venture, but that was not CIEC real attraction. CIEC, above all, has guanxi connections. As a consultancy, and one that has major multinational clients, it specializes in delivering senior government leaders to people who want to talk to them. A consultancy

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ultimately owned by the country’s cabinet can do this. So as well as gaining a bunch of Chinese accountants in urgent need of training (like all its rivals), C&L also acquired a partner for its consultancy operation in China and a proven facilitator for life in general. When the C&L board came to China in January, it was given the full works with Li Peng at the state guesthouse and put on CCTV. In April 1993, C&L employed 36 people in Beijing and less than 20 in Shanghai. By the beginning of 1996, the company had 220 people in Beijing and 140 in Shanghai. To a large extent, this growth reflects the tidal wave of multinational clients coming into China during the period. But that is not the whole story. According to China Chairman John Stuttart, C&L’s Beijing joint venture will derive up to half its revenue this year from local Chinese companies, but the market share is important. Like rivals Arthur Anderson and Price Waterhouse, C&L has been forced into a hiring frenzy in the past couple of years. CIEC’s Deputy Chairman Dean Yoost says human resources is by far the most consuming problem he faces. He could, says Mr. Yoost, run a China operation of 1000 employees if he could find the right people; he dreams of discovering a hidden source of Chinese certified public accountants (CPAs). Of course, there is not one. This means that C&L has 45 expatriates in China at present and their cost, like the cost of most expatriates, is painful. More than 35 000 candidates sat China’s CPA examination last year, but the pass rate was only ten percent. Of the candidates put forward by C&L, 36 percent passed; that does not, however, says Mr. Yoost, mean that they can all speak the fluent English needed to work with the senior executives of multinational firms. Language, as well as professional qualifications, is a headache. C&L is trying everything it can to beat the human resource constraints. The company opened a training center in Shanghai last year; it sends its ablest recruits on year-long secondment to overseas practices; its in-house newsletters exhort employees to practice English, be polite and study accountancy. The effort has all the energy of a Maoist political campaign but its ends are rather more benign. As in all service industries, margins are a big secret among accountants. But C&L executives give some useful indications of where they can take a

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better opportunity. C&L’s better paid work in the short term is auditing and tax and business advisory for multinational clients. They are used to the sort of rates that accountants charge. And in its Shanghai-based consultancy business, backed by 19 expatriates, C&L believes it deserves a premium for the industry-specific expertise it has built up. In pharmaceuticals, telecommunications and fast-moving consumer goods, the company has dedicated teams whose aim is to know more about a particular industry than their rivals. China has come alive for accountancy firms. But partners like those who have built up C&L’s practice are not about to see their bonuses quadrupled. To give some perspective, in Hong Kong, a single city, C&L has 900 employees. It will not have that many in the whole of China for some time to come. Source: Adapted from Anonymous, “A Whole New Ball Game,” Business China, April 1, 1996, pp. 6–8.

Minicase 3: Will Technology and Globalization Undermine Old Networks like Guanxi? Networking websites are booming, but they have not supplanted more traditional business networks. French business may be particularly full of networks, but every country has its cliques, whether based on education, social background, or spiritual beliefs. In Spain, Italy, and Latin America as well as France, businesspeople speak of the influence of Opus Dei, a conservative Catholic lay order which supports a number of business schools. America has its Ivy League alumni groups and Rotary clubs. Chinese businesspeople often rely on guanxi. At the same time, online professional networks such as LinkedIn, headquartered in California, Viadeo, a French-owned website, and Xing, a site with a strong presence in German-speaking countries, are surging in popularity. Online networks, in contrast to the old kind, are open to all and easy to join. Old-style networks, however, are usually stronger than online ones, and the trust between their members facilitates transactions of all sorts.

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They can be particularly helpful for young companies in emerging markets. Social networks can also be speedier than formal systems: in July 2002, for example, when Vivendi, a French conglomerate, was weighed down with debt and needed to raise EUR 3 billion (then $3 billion) in three days, its chief executive at the time, Jean-Rene Fourtou, turned to a group of bosses who were fellow rugby fans, including Claude Bebear, then the chairman of the AXA Group, an insurance firm, and the money was secured. Some old-style networks aim to bring an ethical dimension to business. But networks can also have baleful effects. They sometimes abet crimes. At French firms, there is often pressure to hire or promote people based on their connections, businesspeople say. On the face of it, networks are less important in more meritocratic America. But a 2007 study of mutual funds by Lauren Cohen and Christopher Malloy of Harvard University and Andrea Frazzini of the University of Chicago found that American fund managers invested more money in firms run by people who attended the same university as them. Moreover, membership of Rotary “service” clubs, which started in Chicago in 1905 and have since spread across the world, is by invitation only, and women were not admitted until the late 1980s. The Lions Club International, also based near Chicago, may be the most global offline business network, with 1.3m members in more than 200 countries. A third business network is the Benevolent and Protective Order of Elks, members of which must be Christians. Will technology and globalization undermine old networks? In some cases, they are weakening. Swiss banks’ hierarchies, for instance, used to bear a resemblance to those of the country’s army, with strong connections between the two. But the network has largely disappeared, thanks to globalization and a decline in the army’s role in society, says a Swiss banker. Guanxi are different from Western networks: they are much more personal, informal, and subtle. Their importance is also diminishing as the Chinese economy becomes more market-oriented, says Derek Ling, founder of Tianji.com, a networking site owned by Viadeo. “An active, open online network is far more competitive in today’s globalized business environment than local, closed networks such as alumni groups or freemasonry,” argues Reid Hoffman, founder of LinkedIn. Online networks’ most compelling advantage, in addition to openness and efficiency,

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is the chance they offer to connect across borders and among different sorts of people. Traditional networks, by contrast, tend to be strongest in domestic industries, such as construction. About two-fifths of LinkedIn’s members are female, whereas offline networks are usually dominated by men. And online networks include more entrepreneurs than traditional groups: they make up 30% of Viadeo’s subscribers, according to Dan Serfaty, the website’s co-founder. Nevertheless, the old structures will not fall away soon. Indeed online networks can reinforce offline ones. A graduate of HEC might use the school’s own website to look for any alumni working at, say, Google, Serfaty says. But using Viadeo’s tools, he can also do a broader search for anyone who attended HEC and knows someone working at Google, so the network becomes more powerful. Online networks make it easier to gather information on firms and their employees. But if you want to influence a big decision or secure a job, old networks still count. Source: Adapted from “Business: Joining the club; LinkedIn v freemasons”, anonymous. The Economist, London, Vol. 391, Iss. 8637, Jun 27, 2009: 69–70.

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3 GUANXI AND BUSINESS PERFORMANCE

Guanxi networks affect managers’ strategic choice and hence impact the performance of the firms they lead. Guanxi has a direct impact on market expansion and sales growth of Chinese firms by affecting resource sharing and social, economic, and political contexts in inter- firm transactions. Managers devote time and effort to develop interpersonal guanxi that contributes to the sales growth of their organizations and financial gains and career promotions for themselves. This chapter begins with an introduction to a conceptual foundation of guanxi networks in relation to firm performance. The next section illuminates the influence of two forms of guanxi, one with other businesses and the other with government officials, on two major aspects of performance, namely market growth and financial return. The third section outlines meta-analytical review of guanxi and its value. This chapter ends with practical examples concerning how guanxi contributes to firm performance in China.

3.1 CONCEPTUAL BACKGROUND Strategic choices that managers make inherently reflect their background and experience. As a result, managerial ties and contacts, especially interpersonal relations cultivated by top executives outside the boundaries of the firm, are believed to affect firms’ strategic choice and hence impact their performance. As first elaborated by Cyert and March (1963), managers often have to make decisions under environmental uncertainty. Lack of complete information

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forces them to economize on search processes, relying on efficient channels to acquire information. While documentary media such as written reports also contain needed information, managers, especially top executives, greatly prefer information from personal contacts. Contributing to this preference are several advantages that informal ties offer over documentary media, such as timeliness, richness, and the avoidance of report writers’ bias. Managers typically spend only a small amount of their time in formal planning and analysis, and spend most of their time informally interacting with superiors, subordinates, and people outside their organization. Managers with better managerial ties tend to earn more income, get more frequent promotions, and have better careers. Empirical researchers interested in such a link have paid a great deal of attention to the effect of interlocking directorates in Western corporations. In the network literature, there has been ample empirical evidence that interorganizational ties improve performance for the whole group. Based on several case studies of hospital networks, Thomas and Trevino (1993) show that networks are able to improve performance by reducing uncertainty and equivocality in decision-making through proper information processing mechanisms. Unlike those that focus on collective performance at the network level, several studies have recently explored the impact of networks on individual firms (Goes and Park, 1997; Pennings and Harianto, 1992). Sociological studies on networks focus on organizational isomorphism, mortality, and survival. They suggest that organizational ties buffer firms from failure and provide survival advantages even under intense levels of competition or during organizational transformation. Recently, several studies in the strategy literature addressed the impact of organizational ties on firm- level strategic decisions and outcomes such as service development or innovation. Pennings and Harianto (1992) present strong evidence supporting the enhanced adoption of innovations among networked banks. Goes and Park (1997) also show wide diffusion of service innovations among hospitals tied together through direct and indirect networks, facilitating the sharing of information, resources, and managerial capabilities. Miles and Snow (1984) imply that cooperating firms also benefit from political influence, controlling information, and brokering new cooperative arrangements. The guanxi network is more than just a symbolic representation of personal and organizational ties. It is a utilitarian mechanism for Chinese firms; resource

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exchanges occur independently of the active, conscious participation of the organizations and individuals involved. As posited by the resource dependence theory, resource transactions among guanxi members indicate the degree of influence on organizational decisions shared by these cooperating firms. As organizations continue their interactions with other firms and government officials through the guanxi network, there is a deliberate diffusion of information and accumulation of resources and capabilities. Cooperative firms in the guanxi network basically act as resources to each other, contributing to enhanced survival and growth through planned and unplanned exchanges of personnel, market information, money, facilities, or political favors. Goes and Park (1997) argue that these exchanges encapsulate technical learning and competence enabling innovative capabilities to cross actively among network firms. Research has also shown managerial ties embodied in interlocking ties to be linked to executive compensation, the independence of boards, the propensity to acquire, and the likelihood of adopting poison pills and golden parachutes. Geletkanycz and Hambrick (1997: 654) reported two relationships: (1) top managers’ external ties are related to “strategic conformity, defined as whether a firm’s strategy conforms to or deviates from the central tendencies of its industry”; (2) alignment of executives’ external ties ... with the firm’s strategy enhances organizational performance. We suggest that China’s emerging economy represents a promising, new empirical context. Given its unique culture, history, and size, China is hardly a “typical” emerging economy, which is a label, shared by a heterogeneous group of 24 other countries, such as Argentina, India, Russia, and South Africa, according to The Economist (1998: 94). However, one common feature permeates emerging economies such as China, namely, institutional voids due to the lack of certain market-supporting institutions which lead managers and firms to often perform basic functions by themselves, such as obtaining market information, interpreting regulations, and enforcing contracts. In such an environment where formal institutional constraints, such as laws and regulations are weak, and informal institutional constraints, such as those embodied in interpersonal ties cultivated by managers, may play a more important role in facilitating economic exchanges and hence may assert a more significant impact on firm performance. Averaging nine percent annually since 1979, the phenomenal growth of the Chinese economy has caught worldwide attention. Since the growth

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of the economy ultimately boils down to the growth of individual firms, thousands of Chinese enterprises must have successfully grown during the transition. While not all firms are successful, and state firms in particular have done poorly, a substantial number of firms, mostly non-state ones such as collective, private, and foreign-invested enterprises, have experienced spectacular growth. Given the widely reported, underdeveloped nature of China’s institutional structures, researchers and practitioners alike are puzzled by the question: How can China be achieving rapid rates of growth while retaining [such] an institutional order? A partial answer seems to lie in the interpersonal ties across organizational boundaries cultivated by managers that serve as substitutes for formal institutional support and as access to information and resources in a highly volatile and turbulent environment.

3.2 GUANXI AND FIRM PERFORMANCE Guanxi with Other Businesses Although managers all over the world devote a considerable amount of time and energy cultivating interpersonal ties, Chinese managers rely more heavily on the cultivation of personal relationships to cope with the exigencies of their situation. Nee (1992) focused on the extensive ties between managers and local officials, which he called “collective hybrids.” He argued that for newly founded firms, a “collective hybrid” strategy leads to better institutional protection, which can be provided by local officials, and hence to better performance. Similarly, Walder (1995) argued that the dense ties cultivated by managers and local officials in China’s township and village enterprises serve as an effective governance mechanism, which has resulted in these firms’ superior performance relative to others. Boisot and Child (1996) argued that the traditional “markets versus hierarchies” typology needs to be expanded in order to account for firm behavior and performance in China. In addition, Peng and Heath (1996) identified a growth strategy that is neither market nor hierarchy. What is at work seems to be a process of “boundary blurring” in which interpersonal ties cultivated among managers and government officials are translated into interorganizational ties aimed at better firm performance.

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Building guanxi centers on the notion of networking. As a jargon used in business, networking means knowing the right people and making connections to accomplish individual and organizational goals. In recent academic literature, networking is defined as an individual’s attempt to mobilize personal contacts in order to profit from entrepreneurial opportunities, or a firm’s effort to cooperate with others in order to obtain and sustain a competitive advantage. There are two specific kinds of guanxi networks that managers cultivate in China. The first one is with managers at other firms, such as suppliers, buyers, and competitors. Good relationships with suppliers may help a firm acquire quality materials, good services, and timely delivery. These relationships may also reduce the firm’s purchasing costs and provide the firm with a greater commercial credit line or longer credit terms from suppliers. Such commercial credits are beneficial to firm performance because the government’s tight monetary policy needed for implementing a “soft landing” for the economy has resulted in liquidity problems for most businesses. Similar ties with buyers may spur customer loyalty, sales volume, and reliable payment. Such ties with buyers may also propel the firm’s organizational image, improve its distribution effectiveness, and reduce its costs for marketing and promotion. Good relationships with managers at competitor firms facilitate possible inter-firm collaboration and implicit collusion, while minimizing uncertainties and surprises. Superior relations with competitors may also boost information flows and price harmonization among rivals, which in turn enhance their common benefits. Previous research found that the more uncertain the environment, the more likely these informal ties will be mobilized to facilitate inter-firm relationships (Gulati, 1995). Overall, these ties with managers at other firms can be regarded as an opportunity set for inter-firm relationships, or as lubricant in exchange relations which serves to reduce transaction costs (Williamson, 1985) or to increase benefits (Burt, 1997). As a result, good relationships with managers at other firms are likely to boost firm performance in such an environment. In sum, guanxi has a direct impact on the market expansion and sales growth of Chinese firms by affecting resource sharing and social, economic, and political contexts in inter-firm transactions (Kao, 1993; Luo, 1997 a,b,c). Managers devote time and effort to develop interpersonal guanxi that

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contributes to the sales growth of their organizations and financial gains and career promotions for themselves (Luo and Chen, 1996). It is thereby believed that the guanxi possessed by a firm’s managers with managers at other firms are positively associated with firm performance. It should be cautioned, however, that all these discussions, before and below, are based upon an assumption that major guanxi principles and traditional norms are still held. When these norms are violated or the society is demoralized, guanxi and corruption will be intertwined, which may result in some unintended negative outcomes.

Guanxi with Government Officials Given the uncertainties with Chinese legal standards, the practical benefits of guanxi come from personal connections and loyalties. Most recently initiated rules and regulations remain ambiguous and their enforcement subject to the personal interpretation of government officials. Scarce resources are allocated primarily according to guanxi relations rather than bureaucratic rulings. In essence, guanxi facilitates business dealings while formal bureaucratic rules often inhibit them. Guanxi thus establishes a balance in the cumbersome Chinese bureaucracy by complementing ambiguous bureaucratic rules with personal relations. Chinese firms can circumvent bureaucratic hurdles through personal networks. This makes guanxi vital for the performance and survival of Chinese firms. While personal ties with managers at other firms have been useful in relatively stable Western economies such as the United States, a unique set of ties that managers in emerging economies such as China need to cultivate are those with government officials. Despite nearly 20 years of reform, officials at various levels of government still have considerable power to approve projects, allocate resources, and arrange financing and distribution. The upshot is that bureaucrats occupy a central position in the complex web of relations that firms have to manage during economic transitions. Therefore, arbitrary intervention from the government remains a constant danger to many firms in the absence of a stable legal and regulatory environment. Although China has enacted thousands of laws, rules, and regulations, almost none is completely enforced. Rather than depending on an abstract

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notion of impartial justice, Chinese businesses would prefer to rely on their contacts with those government officials that have the power to get things done. A practical consequence of managerial ties is that personal connections are often more important than legal standards. For instance, whenever scarce resources exist, they are largely allocated through personal ties with government officials rather than bureaucratic rules. Thus, managerial ties provide a balance to the cumbersome Chinese bureaucracy by giving individual businesses a way to circumvent rules through the cultivation of personal relations. In such an environment, it is not surprising that Chinese managers reported in a previous survey that among eight environmental factors that have an impact on firm performance, the state regulatory regime is the most influential, most complex, and least predictable. Given the need to co-opt sources of environmental uncertainty, Chinese managers naturally maintain “disproportionately greater contact” with their administrative superiors. It follows then, that those managers with better ties with government officials may be able to navigate the uncertain waters better and lead their firms to higher performance. In general, superior ties with government officials facilitate a firm’s access to regulated industries, constrained market segments, and production factors (especially scarce raw materials and capital procurement). Such ties also help a firm’s infrastructure access, distribution arrangements, wholesale networking, and project location selection. These benefits will in turn inflate revenues or reduce costs for the firm. Therefore, guanxi possessed by a firm’s managers with government officials may be positively associated with firm performance.

Market versus Financial Performance Although guanxi is constructed on personal relations and favor exchanges, it brings obligations and costs, i.e., renqing, to its beneficiary. Guanxi is reciprocal and utilitarian, and a favor obtained by a firm implies an obligation or a liability that has to be repaid sooner or later. This is essential in managing guanxi because breaking the reciprocal rule seriously impairs one’s social status or “face.” Cultivating and sustaining guanxi can be costly in meeting reciprocal demands even though it contributes to the firm’s sales growth.

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Obligations to personal attachments and ties sometimes hinder business changes that are necessary to improve the firm’s efficiency. The guanxi network does not necessarily contribute to profit growth because of these costs, liabilities, and attachment inertia problems. These problems are aggravated during economic reform and structural adjustments because guanxi cultivation requires a large sum of monetary investment. While managerial ties are costly to maintain, the cost of not having these ties in the right place with the right players may be even more prohibitive. In other words, compared with the possibility of not being able to undertake certain transactions, it pays to have certain ties. To use the terminology of the resource-based perspective (Barney, 1991), social capital embedded in these ties may be regarded as valuable and unique intangible resources which are very difficult to replicate by competitors, thus giving firms which possess them a significant competitive advantage (Burt, 1992, 1997).

Necessary versus Sufficient Condition On the other hand, in China’s increasingly competitive and marketdriven economy, managerial ties may not be the only factor influencing firm performance, despite their widely acknowledged importance. After all, a firm has to deliver added value in the marketplace and traditional performance determinants articulated in the strategy–conduct–performance (S–C–P) paradigm, such as quality and advertising, may also be important. For example, product quality, independent of managerial ties, may have a profound influence on firm performance. Promotional efforts like advertising are also likely to be important. Pricing strategy may directly influence a firm’s performance as Chinese consumers are traditionally very price-sensitive (Luo, 1995). As a major determinant of customer responsiveness, delivery is also important in an increasingly competitive environment. Finally, terms of payment may also influence firm performance, since many firms are unable to collect payment from their buyers who may have difficulties collecting money from their own buyers — a phenomenon called “triangular debt” in China. The current ratio (i.e., current assets/current liabilities) in many

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Chinese firms is less than 1 (Luo, 1995), far below the internationally accepted standard for reasonable liquidity (normally 2:1). Thus, firms that can deal better with payment problems are likely to perform better. Overall, Yeung and Tung (1996: 60) reported qualitative findings that managerial ties alone are not enough to guarantee long-term success in China. Therefore, we expect that managerial ties constitute an important factor influencing firm performance, but they may be insufficient to explain and predict all performance variations by themselves. Figure 3.1 outlines how firm performance is affected by guanxi as well as other internal and external factors.

Legitimate Guanxi

Facilitates

Facilitates

Promotion Distribution Material Supply Customer Loyalty

Financing Government Support Uncertainty Avoidance Quota/License Procurement Earnings Retainment

Technical and Operational Skills

Firm Performance

Organizational and Managerial Skills

Industrial Environment National Environment International Environment

Figure 3.1. Guanxi and firm performance.

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Empirical Evidence Based on an empirical analysis of survey data recently collected (1996–1997) containing 127 firms, Peng and Luo (2000) find the following results: First, guanxi with other managers and government officials are both significantly correlated with sales growth. In addition, ties with government officials are positively correlated with profit growth whereas ties with managers at other firms do not correlate with profit growth. Overall, guanxi networks with government authorities have a stronger linkage with performance than ties with other businesses. Second, overall guanxi is positively related with sales growth but not with profit growth. This implies that guanxi is more strongly linked with sales growth than with profit growth. After controlling for ownership type, firm size, and industry effect, the regression test further shows that ties with managers at other firms have a significant and favorable impact on firms’ sales growth. However, such ties have no important effect on profit growth. Ties with government officials, on the other hand, have a positive effect on both indicators of firm performance at a statistically significant level. The following quotations from several managers, on the importance of maintaining good relationships with government officials, triangulated the above quantitative findings: All these officials, who can be regarded as your “mothers-in-law,” absolutely have to be pleased. If you fail to do that, you may be forced to close your factory without knowing what’s wrong at all. Nobody wants this to happen. When that happens, you can forget about achieving growth and having good performance. If managers at other firms could be regarded as our brothers, then government officials could be seen as our parents or in-laws. As in a family, these relationships are different, and we simply could not afford to have bad relationships with either one of them.

Third, the regression analysis also illustrates different effects on the two different performance measures from managerial ties with other businesses.

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Corroborating with the results from the correlation and canonical tests, ties with managers at other firms have a significantly favorable impact on the firm’s sales growth, but no such an influence on its profit growth. Some of our interviewees suggested that such a finding made sense. One manager told us: For a collective startup like us, it is absolutely critical to have good relationships with our diverse clients.... So we have worked hard to be their friends, by sending them gifts, taking them out to dinner, and occasionally giving them “red envelopes” [containing cash].... Don’t ask me how much money there is in the “red envelope,” I don’t remember. But my point is that this money has to come from somewhere; we don’t print money. These activities directly reduce our profits. But as long as they keep buying our products, we figure it is worthwhile.

Fourth, as far as the multivariate effect (on overall performance) is concerned, managers viewed product quality as being most important, followed by guanxi, terms of payment, delivery, pricing, and, finally, advertising. All these six business determinants have significant impact on firm performance. This suggests that guanxi is important to, but not a sufficient condition for, overall performance enhancement. The above evidence corroborates Yeung and Tung’s (1996) survey findings. They find that among 11 business determinants, guanxi was the only item that was consistently chosen by managers as a key success factor. The weight of guanxi on long-term business success is significantly higher than any other business variable. While recognizing the importance of guanxi, however, most of their respondents (executives) agreed that guanxi alone is not enough to guarantee long-term success in China. The significance of guanxi in ensuring continued success decreases over the life of the foreign venture in China. Once the operation is established, other conditions must be met to sustain success and, of these conditions, technical competence is most important. The business must supply high-quality products, adopt suitable business strategies, and possess in-depth knowledge of the market. One manager characterized guanxi as only one of three cardinal requisites

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for business success in China. He called these requisites the three Cs — capital, capability, and connections. Another manager likened guanxi to a boarding pass that enables the bearer to explore a treasure island. “There is no guarantee that they will find wealth even if they are permitted access.” Similarly, McGuinness et al. (1991) find that the most important factors in winning sales in China are product quality, promotional effort, and service, despite the importance of guanxi. Competitors whose quality levels are not of the highest, may have to exert more than average promotional and service efforts to capture sales to Chinese businesses. An entry strategy of being first, ahead of other Western competitors, also seems to have paid handsome dividends. Chinese managers seem to demand mainly that prices are in keeping with the quality being offered, and that there be some flexibility on matters such as technology transfer and countertrade. Efforts to gain higher preferences through developing guanxi seem to pay off, providing the company’s services are also good. However, for Western companies with only limited knowledge of the Chinese language, customs, and systems, it would seem difficult, if not impossible, to depend heavily on building guanxi with the Chinese.

3.3 M  ETA-ANALYTICAL REVIEW OF GUANXI AND ITS VALUE Prior studies of the guanxi-performance link provide mixed results. In this section I present a meta-analytical review I conducted with my two coauthors (see Luo et al., 2012). This project systematically reviews and quantitatively assesses the guanxi-performance link in a meta-analytic framework. Based on 256 effect sizes from 60 studies encompassing 66 310 firms, we estimate that the effect size of guanxi-performance relationship is positive and significant, endorsing the argument that guanxi enhances firm performance. Guanxi with business partners exhibits a larger effect size than with government authorities. The link between guanxi with business partners and overall performance is shown with the strongest effect size, followed by the link between guanxi with government authorities and competitive performance and between guanxi with business partners and social performance. Moderating tests suggest that the guanxi-performance

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link is stronger for state-owned firms or firms in high-tech industries, or when using direct guanxi measures or objective performance measures. This link is weaker as industry-level competition intensity increases or nationallevel marketization fortifies. Although it remains to be a powerful tool in enhancing firm performance, guanxi’s importance in spurring multiform performance is declining. Following three seminal articles of firm guanxi — Peng and Luo (2000), Park and Luo (2001) and Luo (2001) — where the direct measure of the construct was developed, marketing and management scholars have shown escalating interests in examining how guanxi between firm boundaryspanning managers affect organizational performance and relationship outcomes. Indeed, based on Google scholar statistics, these three articles have received several thousand citations combined in the past. Despite the increasing interest on firm guanxi and performance linkages, the overall relationship is inconclusive (see Chen et al. for an integrative review, 2013): it ranges from a positive linear relationship (e.g., Peng and Luo, 2000) to inverted U-shaped (e.g., Luo and Chung, 2005) to even negative (e.g., Shi et al., 2006; Fung et al., 2008). In other words, extant empirical studies of guanxi have shown an inconsistent impact on firm performance, mostly in terms of the magnitude and a few of the direction. The wide-ranging mixed results of guanxi-performance linkage called for researchers’ attention, yet no study analytically reviewed and integrated findings in this research stream. Therefore, my coauthors and I (see Luo et al., 2012) did a meta review with a two-fold purpose: assessing the overall effect size of the impact of guanxi on firm performance and explaining inconsistencies in prior findings by examining moderators of theoretical relationships. Such a quantitative integration requires a meta-analytical approach. Meta-analysis, a technique that statistically aggregate empirical results, enables us not only to discern the relationship between guanxi and firm performance and estimate the magnitude of the relationship but also to account for contextual issues in guanxi research and investigate substantively the influence potential contingencies and statistical artifacts on the relationship. In meta-analyzing 60 studies involving 66 310 firms, we attempted to make several contributions to the field of strategic management and research on guanxi. First, we focus on the multiple dimensions of guanxi (i.e., guanxi

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with different stakeholders) and multiple outcomes of firm performance (e.g., financial performance, market performance, etc.), and estimate separately the effect of each guanxi dimension on each performance outcome, thus clearly explaining the wide variety of guanxi-performance linkage across studies. Second, we developed and tested a theoretical framework incorporating internal and external contingencies that are critical in the guanxi research. Such an approach of multi-level moderators allows a comprehensive understanding of the contingent relationship between guanxi and firm performance. Third, this meta-analytical study adds significant value to our understanding of the guanxi construct, by comparing the methodological factors such as measurement and research design. In addition, we were able to longitudinally test how the guanxi-performance link evolves with the institutional environment, an evolutionary element that cannot be easily tested in a single study.

Literature Search We employed multiple search techniques to identify empirical studies that included guanxi and firm performance. First, we conducted an electronic search in ABI/Inform, EBSCOhost, PsycInfo, Elsevier Science Direct, and JSTOR, using a combination of keywords such as “guanxi”, “ties/networks/ relationship”, “social capital”, and “managerial ties”. Second, we manually searched the following journals: Academy of Management Journal (AMJ), Strategic Management Journal (SMJ ), Administrative Science Quarterly (ASQ), Journal of International Business Studies (JIBS), Asia Pacific Journal of Management (APJM) and others considered the most highly cited journals in this field of management. Third, we gathered unpublished works by searching Dissertation Abstracts and conference proceedings in marketing, management, and international business areas for the previous five years. Since we attempted to unveil the relationship between guanxi and firm performance and its various moderators, empirical studies in our collection met a few key criteria: (1) the dependent variable(s) must contain firm performance, (2) independent variable(s) must entail guanxi or its synonymy,

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and (3) an empirical setting must be in the greater China context (mainland China, Taiwan, and Hong Kong). This multipronged process yielded 60 studies. For studies with multiple independent samples, correlations from each sample were included (e.g., manufacturing vs. servicing, state-owned company vs. foreign company, mainland China vs. Hong Kong). If a sample reported more than one correlation for a single relationship (e.g., with regard to business tie, it provides separate correlations with performance for suppliers and customers respectively), we combined these correlations into a linear composite correlations using formulas provided by Hunter and Schmidt (2004).

Meta-Analytic Techniques We adopted r-family statistics for our effect sizes since they are scale-free. Specifically, we recorded the zero-order correlation (r) between guanxi and outcomes as our effect size to eliminate different control variable effects among studies included. For studies not reporting r, we recorded t-statistics or p-value, which was transformed to r later. The explanatory variables accounting for heterogeneity (i.e., moderators) were measured as dummies except publication year, which is a continuous variable. When primary studies used the unbalanced data or pair-wise deletion, the correlations in a matrix could be based on different sample sizes. In such cases, we recorded the smallest sample sizes shown as a conservative choice (Cooper et al., 2009). After pilot-testing and refining, we had two coders rate the above 60 studies separately, with an inter-rater coefficient being over 90 percent. All discrepancies were resolved before analyses began. We computed Huffcutt and Arthur’s (1995) sample-adjusted metaanalytic deviancy (SAMD) statistic to detect possible outliers. The result did not show any significant outliers. We finally have a dataset of 256 correlations from 60 studies with a total sample size of 66 310 firms. Of total, 45 were published after 2005. Regarding the authorship, 20 out of the total were written by U.S.-based scholars, 12 by western and Hong Kong-based scholars jointly, and 11 by western and mainland China-based

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scholars jointly. Among the total, 11 appeared in APJM, 6 in JIBS, 5 in SMJ, 2 in AMJ, and 2 in ASQ. Following Hunter and Schmidt’s (2004) suggestion, we corrected the unreliability of individual correlations through dividing the correlation coefficient by the product of the square root of the reliabilities of the two variables. For those studies that did not report reliability values, we used the average reliability estimate of other studies that explored the same relationship. We next calculated weighted mean correlations by applying Fisher’s Z transformation procedure and finally get the reliable corrected and sample weighted population correlation coefficient. Finally, we conducted a meta-analytic regression to assess whether internal and external moderators, statistic artifacts (i.e., methodological moderators), and study characteristics (i.e., publication year; published vs. unpublished; author affiliation) are related to the heterogeneity of effect sizes simultaneously. Moreover, we reported weighted regression for both fixed- and mixed-effects. Further, a vote-counting method was adopted when we could only attain regression coefficients, rather than correlation coefficients, of interaction terms (i.e., guanxi-capability and guanxi-market intensity).

Meta-Review Findings For detailed meta-analytical results, please see Luo et al. (2012). Below, I merely highlight some key important conclusions we found:

Multidimensional guanxi and its multiform value Between two dimensions of guanxi ties, ties with business partners exhibits a larger effect size than ties with government authorities on firm performance. While the role of government ties in facilitating a firm’s success cannot be underestimated given the considerable power possessed by Chinese officials in controlling critical resources, market entry, and policy treatment, guanxi with business partners has shown a more prominent role in achieving overall superior performance. This may be ascribed in part to the fact that business ties are more reciprocal, resilient, and transparent than government ties.

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Further, as market economy increasingly dominates in China, reflected in rapid growth in private sectors and fundamental increase in both domestic and international trade and investments, relationships with non-governmental business stakeholders, such as buyers, suppliers, distributors, logistics agencies, and professional service providers, are becoming pivotal to firm growth and business expansion. Such business ties especially benefit the firm in resource sharing and reciprocal support, both imperative in a market featured with high velocity, dynamism, and vibrancy. When firm performance is decomposed into several forms, we find that business ties exert the strongest effect on overall performance, followed by social performance and competitive performance. On the other hand, government ties have the strongest effect on competitive performance, followed by overall performance and market performance. This finding suggests that guanxi has a weaker effect on financial performance but a stronger effect on other forms of performance (competitive, market, and social-based). This seems to validate to some extent that guanxi, as a social capital investment requiring reciprocal commitment, is indeed not cost-free. Another explanation is that it may involve a longer distance for guanxi to impact financial performance than to affect market, social or competitive performance.

Internal and external contingencies Our results confirm that a firm’s internal and external characters moderate the effect of guanxi on firm performance. State-owned firms are found to benefit more from guanxi than non-state-owned firms, providing evidence echoing that state-owned firms tend to use more guanxi and gain more from it today as a dominant mechanism in interorganizational exchanges. This contradicts with several earlier studies (e.g., Park and Luo, 2001; Xin and Pearce, 1996), arguing that non-state-owned firms tended to utilize guanxi more intensively and benefit it more than state-owned firms. As noted below, our study suggests that the temporal dimension plays some important role in explaining evolutions and changes of the guanxi-performance link. This role may also come into play in determining whether state-owned firms gain more from guanxi than non-state-owned, or vice versa. In earlier

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years (1980s–90s), marketization resided in an embryonic stage in China, accompanied with cumbersome and sturdy government control over critical resources and market entry. This put non-state-owned enterprises at a disadvantage, comparing with state-owned rivals which were then largely protected by the central or local governments. This in turn prompted nonstate-owned companies to rely more emphatically on guanxi utilization. This situation has immensely changed as China’s marketization (including factor market, product market, capital market, and intermediary services) dramatically increases and government control over resources and market entry markedly decreases. At present, non-state-owned firms become less dependent on guanxi with regulators and other business stakeholders than before. On the other hand, they have to spend more in building and maintaining guanxi than state-owned counterparts given the increasing intertwinement between guanxi and corruption (Luo, 2004). While the number of state-owned firms becomes fewer today, an outcome of the central government’s “grasping big and releasing small” adopted since late 90s, they serve as governmental agencies through accentuated nepotism and increasingly use guanxi to uphold this nepotism and retain their monopolistic power. As quasi-government agencies, they also have institutional advantages in terms of cost saving and investments in establishing guanxi ties. Our meta-analysis also suggests that the interaction of guanxi and a firm’s other capabilities, such as production capability, quality, operational experience, contributes to improve firm performance, a finding consistent with several previous studies (e.g., Wu, 2008). This implies that firms should endeavor to increase their competitiveness through developing technological and operational capabilities, concurrently doing so with development and utilization of guanxi. Still, contrary to our expectation, firm size and firm age were not found to moderate the guanxi-performance relationship. While social network strategy has long been recognized to be effective for small and entrepreneurial firms to overcome their resource disadvantages (Li et al., 2008), our meta-analysis suggests that the magnitude of the guanxiperformance link is not significantly different between big and small and between young and mature firms. Although small and young firms incline to maintain an entrepreneurial spirit of cultivating guanxi with both business partners and government authorities to offset institutional and competitive

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disadvantages, they may not have a sufficient and favorable access to established networks or the payoff of network investment may be lagged, unable to contribute to immediate performance. Our meta-analysis also confirms that under different environmental and industrial conditions, the relationship between guanxi and performance varies (e.g., Luk et al., 2008; Luo, 2001). Market competition intensity is found to weaken the guanxi-performance link. For firms operating in highly competitive markets, the criticality of competitiveness increases while the importance of relying on guanxi decreases (Gu et al., 2008). Firms in high-tech industries are found to rely more on social networks and ties from which they can gain intellectual capital and professional services relating to research and development (Li and Zhang, 2007). Further, this meta-analysis exhibits that guanxi seems to be more valueadding in mainland China than in other greater China territories (Hong Kong and Taiwan). It follows that the value of guanxi may be affected by and contingent on the institutional environment along with the levels of economic, legal, and social development. If this holds true, then values of guanxi in enhancing firm performance may gradually decline as the institutional environment improves and economic, legal, and social developments progress.

Evolutionary property The value of guanxi has perhaps never been completely static. This metaanalytical review offers some insight into the debate whether the importance of guanxi will decrease, remain or increase. There are two views toward it. One views guanxi as a deep-seated idiosyncratic cultural fact of Chinese society, and suggest that its importance will continue or even increase at an accelerated rate (e.g., Yang, 1994). The other view looks guanxi in the context of institutional structure as China continues to transform itself into a market-based economy. As market imperfection, institutional voids, and economic transformation all improve, the importance of guanxi will decline (e.g., Guthrie, 1998). Our meta-analysis supports the latter view — economic value of guanxi declines at the firm level.

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Our moderating analysis presents a negative relationship between the effect size and the publication year, reporting that the overall effect size from the longitudinal design is larger than that from the cross-sectional design. The declining property of guanxi’s importance over time reminds us that guanxi is neither a purified nor context-free culture albeit it is deeply embedded in China’s social norms and tradition. Because of its utilitarian and contextual properties (Luo, 2000), guanxi is prone to economic self-interest seeking and opportunity seeking, involves social, affective, and economic investments, and is shaped by institutional, socio-cultural, and economic parameters. As such, the purity of guanxi weakens when the society’s moral standards are downgraded and the intertwinement between guanxi and corruption are upgraded. It seems logical to expect that as guanxi’s purity declines, its value will decline too. Moreover, the interaction and temporal effects reported above consistently suggest that competitive strengths become more essential and more dominant in determining firm performance as China’s marketization increases. Guanxi may no longer be a central force or a dominant factor of firm performance for most Chinese firms.

Methodological moderators Our examination of methodological moderators (i.e., statistical artifacts) also leads to several observations that may call for researchers’ attention. First, regarding the measures of guanxi, we identified two major different measures in previous studies: direct measures, extending from Peng and Luo’s (2000) measure of managerial ties, and indirect measures, such as structure hole index and interlock. Our meta-analysis displays that indirect measures of guanxi incur a larger effect sizes. For example, Luo and Chen (1997) uses sales force marketing and credit liberalization as indirect measures of guanxi, and Luo and Chung (2005) calculated the percentage of members with particularistic relationships in the inner circles. Future studies may adopt both types of measures for cross validation. Second, measuring firm performance is an interesting issue for both scholars and practitioners. There are considerable debates in the literature on transitional and emerging market economies about the reliability of

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performance measures and concerns about the comparative merits of objective versus subjective measures of performance (Hoskisson et al., 2000). While objective measures, such as profit, ROA, ROE, sales growth, revenue, and Tobin’s Q, reflect the fulfillment of the economic goals of firms, subjective measures could reflect broader conceptualization of business performance, such as market share, new product production, product quality, market effectiveness, client satisfaction, and efficiency of production. Our metaanalysis shows that objective performance measures are associated with a larger effect size than subjective performance measures. Future studies may need to pay more attention to this issue and adopt a combination of both subjective and objective measures to ensure an accurate measure of firm performance.

3.4 MANAGERIAL IMPLICATIONS While guanxi has a positive effect on overall performance, it is also interesting to note different influences on different performance dimensions from different types of guanxi. Specifically, guanxi has a significantly positive impact on firms’ sales growth but little influence on profit growth. While ties with government officials have a strongly positive influence on both sales and profit growth, networking with other businesses enhances sales growth but not profit growth. Therefore, managers need to appropriately align their strategic goals (sales versus profit) with the right targets (business versus government) with which managerial ties are cultivated and maintained. Guanxi is a necessary but not sufficient condition for firm success. Despite conventional wisdom suggesting almost unlimited benefits from guanxi, managerial ties alone do not account for all performance variations. This suggests that, while managerial ties are important, a firm also needs to have quality products and services in connection with appropriate payment terms, efficient delivery, and the right pricing strategy, in order to perform well in China’s emerging economy. An underestimation of the importance of managerial ties may reduce the firm’s ability to preempt opportunities and expand in the market. An overestimation of the role of managerial ties

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may make the firm vulnerable to contextual uncertainties and difficulties in responding to changes in industrial competition and market demand. Given that strategic choices are inherently affected by the national culture of managers, it is not surprising to find that Chinese managers resort to interpersonal ties to achieve organizational goals. Culturally, the propensity of Chinese managers to rely on such informal ties is quite high. However, beyond the cultural influence, Boisot and Child (1996) argued that the persistence of informal relations among firms in China is also the result of the failure of hierarchy- and market-based governance structures. As a result, a network-based strategy emerges, which is “neither hierarchy nor market” (Peng and Heath, 1996). Therefore, in addition to the cultural propensity for Chinese managers to rely on interpersonal ties to get things done, the institutional imperatives during the transition toward a market economy further necessitate extensive reliance on personalized exchange relationships in order to attain better firm performance. For practitioners in China, it must be noted that while managerial ties may not always guarantee success, their absence usually leads to failure. What this study contributes is both the extent and limits to which these ties are beneficial. To the extent that these ties are legitimate and helpful, they should be encouraged since entrepreneurial opportunities are usually discovered through these contacts. Managers who know with whom, when, and how to create ties add considerable value to the firm and are likely to lead it to better performance. On the other hand, our results also suggest that despite conventional wisdom, managerial ties alone may not be enough. A successful firm also needs to have a number of strengths in traditional areas such as product quality, credit policy, and pricing strategy. Therefore, beyond a certain limit, managers’ time and resources may be better spent on these areas, as opposed to engaging in excessive tie-building activities. For policy-makers and officials in China and other emerging economies, our findings suggest that while they call for the elimination of corruption, they themselves may also be a significant part of the problem. Specifically, managers we surveyed place a high value on their ties with government officials. As a result, as long as the boundaries between the state and the firm remain blurred, managers will always have a strong incentive to cultivate

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ties with officials. To the extent that our findings can be generalized beyond China, we might suggest that the “corruption” often described by Westerners doing business in many developing and emerging economies may be in part a consequence of weak institutional protection for legitimate business. The hope seems to lie in institution-building efforts, whereby managers, especially those in vulnerable, young, non-state-owned firms, will have faith in the “system” as opposed to their contacts. On the other hand, the rising corruption and other dubious activities can be regarded as a cost of doing business during the current transitional stage. While the level of corruption was low before the economic transition, the scale and scope of business transactions were also minimal. Therefore, the puzzle about why corruption seems to be on the rise during the transition can be answered: To achieve better firm performance, managers often must resort to interpersonal ties, which sometimes lead to corruption, in the absence of an adequately defined legal and regulatory framework.

3.5 PRACTICAL EXAMPLES Minicase 1: Chase Capital Uses Guanxi to Expand its Asian Business Chase Capital Partners is raising a major new buyout fund focusing on Asia and is partnering with the International Finance Corp. and some of Hong Kong’s most prominent families to participate in an expected wave of divestitures and consolidations throughout the region. According to Arnold Chavkin, a partner at Chase Capital, Chase Asia Investment Partners will hold a first close in April on more than US$500 million. Chase began premarketing the effort nine months ago. Although the fund sports a target of US$750 million, the final close may pull in much more than that, Mr. Chavkin said. Additional capital also will be raised from United States and European institutions. Acting on a desire to make the fund as Asia-centric as possible, Chase Capital has enlisted Andrew Liu to head the effort. Mr. Liu is the former president of Morgan Stanley Asia and his family owns Liu-Chong

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Hing Bank, a Hong Kong middle-market consumer bank. Limited partners that have signed on to the fund to date include Chase Manhattan Bank, which committed US$250 million; the IFC, which is the investment arm of the World Bank Group; and several Hong Kong family groups, whom Mr. Chavkin declined to name. The IFC also has agreed to set up a dedicated debt facility for the fund, although Mr. Chavkin said Chase Asia will seek deal financing from any source available. In establishing its presence in Asia, Chase Capital is taking steps to avoid being perceived as a wholly outside institution. Chinese business culture places great value on guanxi, meaning “connections,” and Mr. Liu has guanxi in spades. In addition to having long-standing ties to Chase Manhattan, the Liu family has close connections to prominent business families throughout Asia, as do the family limited partners in the fund. These ties may well help Chase Asia to be perceived as more of a local partner by Asian companies, Mr. Chavkin said. There is an underlying resentment in Asia toward Western money coming in to “take advantage” of depressed prices there, he noted. The presence of guanxi also may facilitate deal flow. Chase Asia will be looking for corporate spin-offs and, to a lesser extent, for minority investments where the firm is allowed a great deal of control. The firm will also back companies seeking to make consolidations. The fund will focus predominantly on Southeast Asia, China, and South Korea, although Mr. Chavkin said the general partners are not ruling out investing in Japan. Several sources who have invested in Asia in the past point out that having access to family networks does not necessarily guarantee good investment opportunities. Crimson Asia Capital Holdings Ltd. in 1997 wrapped a US$428 million buyout fund that it claimed would be able to tap a family network for deal flow. Crimson is an affiliate of the Chialese Financial Group of Companies, a direct investment financial services group owned by the Koos family of Taiwan. Since raising its fund, the firm has had a difficult time finding significant buyout opportunities, a limited partner in the fund said. Asia, including a 1998 deal with Newbridge Asia to acquire AMT, a semiconductor manufacturer, from Astra Microtronics, according to a

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general partner who invests in Asia. Chase Capital has investment offices in Latin America and Europe, but no other dedicated regional funds. The firm also has an investment office in Singapore, but Chase Asia will be based in Hong Kong. Chase Manhattan’s banking activity in Asia dates back to the 1920s, Mr. Chavkin added. Chase Capital is not alone in feeling that private equity capital will become a crucial component in rebuilding Asia’s economy. The Carlyle Group late last month held a US$450 million close on Carlyle Asia Partners, L.P., which has a target of US$750 million. Also, H&Q Asia Pacific, Newbridge Asia and Unison Capital are raising buyout funds targeting the region. Source: Adapted from Snow and Kosman (1989).

Minicase 2: Valuing Connections for Hong Kong’s Red Chips The lines of mourners in front of the New China News Agency office in Hong Kong stretched from the entrance, through a tunnel under the road, and along the green expanse of the Happy Valley race track. In the days following Deng Xiaoping’s death, thousands of people filed into what is effectively China’s consulate in the colony to pay their last respects. Once inside the building, they couldn’t help but notice an ornate flower arrangement placed just outside the designated “mourning room.” A black streamer identified the wreath’s sponsor: Wang Jun, President of China International Trust & Investment Corp., and Head of Poly Technologies, the most important trading arm of the People’s Liberation Army. Of the thousands who came to mourn the passing of a leader and an era, few would have had better reason than Wang Jun. His prosperity, and that of Hong Kong-based Citic Pacific, Citic’s high-profile overseasinvestment arm, have often been attributed to his ties with Deng. Wang’s father, once a Vice-President of China, was a close friend of the patriarch. And Wang is not alone. A number of Chinese companies owe their success largely to the fact that senior executives had the ultimate political guanxi connections and personal relations with Deng and other Chinese leaders. Many of these companies are listed on the Hong Kong Stock Exchange and have for years been favored by investors in Hong Kong.

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If a company was run by a princeling, they reasoned, it would be assured of sweet deals in Beijing. A few years ago, many investors would have dropped “red chips” with Deng connections like so many hot potatoes at the news of his demise. But the February 20 announcement of the patriach’s passing didn’t batter their performance. In fact, Hong Kong’s red chip index leaped even more than the benchmark Hang Seng. Analysts say this is because companies such as Citic Pacific no longer depend solely on their Deng connections to get by; many have institutionalized their status. “The overall climate has changed, and the system has become more market-oriented,” says Tai Ming Cheung, an analyst with Kim Eng Securities in Hong Kong. That is not to say high-level guanxi no longer amounts to much in Beijing, or that princeling-watching will cease to be a popular sport on the HKSE. But the fact that the red chips were unaffected by Deng’s death suggests that the game has become much more complicated and therefore much more risky. It is likely to get even riskier. Princeling-watchers will undoubtedly scrutinize changes in the Beijing hierarchy in the post-Deng era and, accordingly alter their assessment of the red chips. Few analysts expect dramatic changes overnight. “We won’t see much happen in the short term,” argues Li Hui, an analyst with W.I. Carr in Hong Kong. She predicts that everyone would be safe at least until the 15th Chinese Communist Party Congress in October, 1997. That’s when almost half the party leadership was expected to step down, leading to a shift in the relative status of patrons and their dependents. Among those whom some analysts expected to depart from the stage was Vice-President Rong Yiren, the father of Citic Pacific chief Larry Yung. A recent management buyout had helped Citic Pacific develop into a relatively autonomous entity. But the fate of other red chip firms may well be affected by how investors in Hong Kong read the results of the October a red chip’s performance than the outcome of opaque decision-making in Beijing. Much of Citic Pacific’s success can be attributed to the fact that Hong Kong tycoons were willing to sell assets cheaply to the group. But neither Hong Kong nor Beijing can indefinitely prop up red chip companies that have no more than guanxi to justify their existence. Signs

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of this were evident long before Deng’s demise. Take the example of Shougang Concord Grand, the group that counts his youngest son, Deng Zhifang, among its top managers. That wasn’t enough to protect Zhou Beifang, chairman of the group’s listed Hong Kong arm; in February 1995, Zhou was arrested, and subsequently sentenced to life in prison, for “serious economic crimes.” If ties with Deng weren’t an automatic safeguard from the long arm of the law, then connections to other senior leaders are no guarantee of commercial success either. Many Hong Kong investors have had first-hand experience of just how risky betting on princelings can be. When Huaneng International Power listed in the colony in the summer of 1994, many investors were willing to pay a “princeling premium,” because the son of Premier Li Peng was an executive of the company. Others found China Venturetech attractive because it is associated with Chen Weili, a daughter of the late Chen Yun, a former Communist Party elder, and sister of Chen Yuan, Deputy Governor of the People’s Bank of China. In both instances, those connections proved no guarantee of success. Huaneng has been a disappointing performer; China Venturetech’s bubble was punctured by tight money; and another venture associated with Chen Weili, China Finance Trust & Investment, was shut down by the central bank. Moreover, the emphasis on those who are “in” often obscures the fact that even those who are “out” are not entirely without influence. Former Communist Party Chief Zhao Ziyang may have been persona non-grata at Deng’s February 25 funeral, but those close to him still wield influence behind the scene. Zhao’s daughter-in-law, Margaret Ren, is an investment banker in the Hong Kong office of Bear Stearns; competitors say she can still get the Chinese State Council to push lucrative deals to her firm. Still, it can be all too easy to give too much weight to Beijing and to connections in the Beijing capital. The market, for example, bet that by the time of the Hong Kong handover, HKR International, which controls the Discovery Bay development on Lantau Island, would get its long-awaited permission to punch a tunnel through the north of the island to the new airport since Citic Pacific now owns 50 percent of the company. But its chairman, Payson Cha, dismissed such expectations. “July 1 is a nonissue,” he said. “It is the same people [in the government] who are there.

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The delay is just because [the tunnel] is low in the government priorities. That doesn’t change on July 1.” Meanwhile, what did investors in Hong Kong make of the red chips with Deng connections, once he was no more? Many analysts said their ratings would not change much. Deng’s slow fade-out meant many had ample time to institutionalize their status. As one mainland-born investment banker pointed out, they “have had at least a decade to prepare their contingency plans.” The red chip darlings of Hong Kong’s stock-market have long flourished on guanxi: China connections that count. The conventional wisdom is that high-level links ensure smooth operations, and best of all, regular injections of under-priced assets into the companies from across the border. But some investors may be betting too heavily on their connections. Some analysts are starting to wonder if the helping hand of guanxi can haul the red chips over a looming wall of market reality. The problem is an unsustainable vicious circle. “Anticipation of additional injections has driven [share-price] valuations still higher,” says James Clarke, an analyst with Credit Lyonnais Securities Asia in Hong Kong. But, says Clarke, despite low purchase prices for China assets, many red chips are funding their buys with new share issues, forcing down earnings per share and making the need for new low-price asset purchases even greater. A look at two of the hottest red chips listed in Hong Kong, Silver Grant International Industries and China Everbright-IHD, part of the Everbright Group, illustrates both the promise and the peril of playing the China game. Interest in Silver Grant is at least partly due to the fact that its chairman, Wu Jian Cheng, is the son-in-law of Deng Xiaoping. Its connections continue with its major shareholders; the China Construction Bank and China National Nonferrous Metals Industry Corp. But it is more an investment holding company than a firm with a core operation franchise. To generate profit in 1995 and 1996, it had to rely on selling a holding in Hong Kong-listed Qingling Motors. Silver Grant is now counting on listing Jiangxi Copper Co., which it invested in for earnings growth. Recently, it shifted its strategy and now has a stake in the newly formed China Infra-Structure Investment. Compared with other red chips, there are good reasons to back Silver Grant.

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It has always shown an ability to recover profits from its ventures and its president, Gao Jianmin, is rated highly among mainland executives. But its high-level connections have commanded a premium on the market. When the next spate of analysts’ reports on Silver Grant comes out, “I wonder whether they will mention Deng’s son-in-law as prominently,” says Hugh Peyman, market strategist for Dresdner Kleinwort Benson in Singapore. Another of the recent high-performance China stocks has been China Everbright-IHD, which nearly doubled in value in the first quarter of 1997. Everbright has historically disappointed investors, despite the credentials of its backers; it ranks right up there with Citic in the hierarchy of those who report directly to the State Council. In July 1996, former Vice-Governor of the People’s Bank of China Zhu Xiaohua was appointed to head the organization. Many might think Everbright is a hedge against the uncertainty of companies with links to the “princelings” of the Deng era. Everbright is the domain of the bureaucrats. But privately analysts are skeptical. “It is too political,” says one. Moreover, bureaucrats from China have yet to demonstrate that they can function in Hong Kong. Ultimately, whichever side the connections fall under Deng-related, bureaucratic, or new-breed some analysts feel fundamentals have to play a larger part. “Investors will have to reassess all stocks dependent on guanxi,” says Peyman. “They will have to learn that guanxi can be a liability as well as an asset.” Source: Adapted from Sender (1997).

Minicase 3: Alibaba Runs into a Regulatory Ruckus Jack Ma, Alibaba’s chairman, likes to be seen as a self-made man. Other Chinese firms may cultivate their relationships with important Communist officials, but the boss of China’s biggest e-commerce firm has long insisted that he merely dates the government, and it will never lead to marriage. This week he stressed again that he is no red capitalist: “In Alibaba, I fiercely object to making all sorts of complicated, curious guanxi connections.” Mr. Ma is also keen for Alibaba to be regarded as a global innovator: “We are an internet company [that] happens to be in China.” His ambition

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is for Alibaba to serve two billion consumers and tens of millions of small companies worldwide. To further this aim, this week his firm unveiled a partnership with Lending Club, a peer-to-peer platform based in San Francisco, to extend credit to American firms buying Chinese goods on its site. A regulatory kerfuffle shows how Chinese Alibaba remains, however, and how hard it is to have even a harmless flirtation with the government. The first sign of grief was an apparently official “white paper,” published online in January, from the State Administration for Industry and Commerce (SAIC), an agency responsible for supervising China’s internet firms. It described a meeting last July in which a middling official, citing a study of counterfeit designer goods on Alibaba’s portals, lambasted the firm for not doing enough to fight fakes. The regulator claimed that he delayed releasing this document in order not to disrupt the firm’s initial public offering (IPO) last September. The posting was highly irregular and has since been deleted, but it started a commotion. Investors, fearing a regulatory crackdown in China, punished the firm’s shares. Lawyers, arguing that Alibaba may have failed fully to disclose pending regulatory action before its IPO in New York in September, began preparing class-action suits in America. Such is the power of the state in China that local firms rarely protest at a regulator’s official ruling. It is shocking, then, that Alibaba not only challenged the regulator but also denounced the study as unscientific. Mr. Ma even demanded and got a meeting with Zhang Mao, the head of the SAIC, on January 30th. That seems to have smoothed things over. The agency now says that the document was not, in fact, official but rather the minutes of a routine meeting and, disappointingly for class-action opportunists, has no legal weight. The storm appears to have subsided, therefore, but the episode points to two lingering threats. First, investors in Alibaba are now painfully aware that it is exposed to China’s arbitrary and politicized regulatory system. That should worry them. Antitrust authorities elsewhere would probably not allow an e-commerce firm to control a whopping four-fifths of the market, as Alibaba does at home with its Taobao and Tmall portals. Can the company keep its privileged position?

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The second risk arises from counterfeiting. It is wrong to blame Alibaba for China’s love of making and buying fake bags, shoes and other luxury knick-knacks. The firm is fighting bogus goods: more than 2000 employees work to take down more than 100 million fraudulent listings a year. These efforts have won praise even from tough-minded American regulators, who removed Taobao from their annual list of “notorious” fake markets in 2012. Yet shoppers on Taobao can still find counterfeits purporting to be Manolo Blahnik shoes, Coach purses and Ugg boots, all for a few dollars. A firm that aspires to be a world-class marketplace for quality goods needs to do better. Source: Adapted from The Economist (2015).

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4 ORGANIZATIONAL DYNAMICS AND  GUANXI

Although guanxi is embedded in every part of social life in China, companies demonstrate different needs and capacity toward guanxi cultivation. Chinese firms develop legitimate (not corrupted) guanxi as a strategic mechanism to overcome competitive and resource disadvantages by cooperating and exchanging favors with competitive forces and government authorities. This chapter develops an integrative framework about legitimate guanxi development according to institutional, strategic, and organizational factors. The first section outlines guanxi at the organizational level, that is, cross-organizational connections among managers. The next section elaborates the influence of organizational dynamics on guanxi utilization. Firms with heterogeneously institutional, strategic, and organizational attributes use guanxi idiosyncratically. Conclusions and implications are highlighted in the following section and practical examples are offered at the end.

4.1 GUANXI AS AN INTERORGANIZATIONAL NETWORK Guanxi is a cultural characteristic that has a strong implication on interpersonal and interorganizational dynamics in Chinese society. Guanxi is a critical factor for firm performance in China by affecting the flow of resources and interactions of a firm with task environments. As China continues economic reform and property rights remain ambiguous, it has become more imperative to utilize guanxi to manage uncertainty and external dependency. The extent of guanxi networking is idiosyncratic

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to a firm, and depends on various organizational characteristics, such as strategic capabilities and orientations, size, history, etc. These organizational attributes also shape the setting for inter-firm transactions that affect the financial and operational synergy of organizational networking. Chinese firms utilize guanxi to manage organizational interdependence and to mitigate institutional disadvantages, structural weaknesses, and other environmental threats. Institutional, strategic and organizational contexts of the firm are often antecedents in guanxi development. Guanxi cannot be a panacea even in the network-based Chinese society; its effective utilization depends on the fit with institutional, strategic, and organizational attributes. Guanxi becomes an organizational-level asset as personal relationships are dedicated to and used by the organization. Interorganizational guanxi, called guanxi hu, is built on and expanded through personal relationships. A viable organizational-level guanxi requires strong relationships among the key managers in the organizations. As China continues its economic reform, guanxi utilization by firms has become increasingly pervasive and intensive. There are substantial rewards such as a commission, bonus, and promotion for utilizing managers’ personal guanxi for organizational purposes in sourcing key inputs and marketing products. Inter-firm guanxi specifically refers to cross-organizational connections among managers while a guanxi with government authorities addresses personal relationships between managers of the firm and government officials. In recent years, networks and relationship-building have become critical for the success and survival of corporations around the world. Interorganizational networks are increasingly thought to enhance the survival and capabilities of organizations by providing opportunities for shared learning, transfer of technical knowledge, legitimacy, and resource exchange. Organizations connect with others to acquire new technologies and expand their product or market reach. Studies have shown that organizational and technological competencies are often at the nexus of these networks. The literature on organizational networks has grown dramatically in the last decade and a variety of theoretical approaches have been offered. Indeed, Galaskiewicz (1985) argues that there is no one theory of interorganizational networks. Oliver (1990) also illustrates that the decision to initiate relations with another organization is commonly based on multiple

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contingencies. Levine and White (1961) focused early attention on exchange (and reciprocity) as the driving force behind interorganizational structuring. Consistent with the open-system perspective, the resource dependence or exchange model has been the dominant organizational rationale for interorganizational networks (Pfeffer and Salancik, 1978). It suggests that organizations are dependent on their task environment for inputs that are essential for their functioning. Since organizations cannot internally generate all needed resources, they must exchange with other organizations to obtain those resources. Because such resources are often scarce and organizations tend to compete for them, the resource dependence model focuses on interorganizational efforts to gain power and control over essential resources while minimizing threats to organizational autonomy (Cummings, 1984). Interdependence within a network manifests power, trust, legitimacy, and differential advantage in the economic base. Facing environmental turbulence, organizations are often not sure what strategic directions to follow. Sociological studies have extensively documented how ideas and know-how spread throughout a population via networks (Rogers, 1983). Firms use networks to overcome the uncertainty and distrust that plague economic transactions. According to the sociological view, firms adopt networks as a mechanism to mimic other successful firms’ strategies under uncertainty. Galaskiewicz and Wasserman (1989:456) argue that “organizational decision makers see how other organizations cope with environmental conditions similar to their own and thus get some idea as to how to behave themselves.” Organizational decisions thus reflect the result of inter-firm contagion within a network. Organizations avoid uncertainty and enhance social legitimacy by mimicking others in the network. The social problem-solving perspective suggests that when the larger social field within which relevant organizations are embedded becomes more complex and turbulent, organizations encounter problems and areas of uncertainty with which they cannot cope alone. In general, open-system models predict that exchanges occur when two or more organizations perceive mutual benefits from interacting to gain the necessary resources (or legitimacy) or by negotiating a more stable competitive order, thereby reducing turbulence to more tolerable levels. Under the institutional perspective, organizations experience pressure to conform to common

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understandings of effective and efficient structure and behavior. While the resource-based approach views legitimacy as a resource for organizations to obtain and exchange for material resources, an institutional perspective illustrates that organizations gain legitimacy for their operations through isomorphism with the environment, i.e., by conforming to commonly accepted structures and procedures (Goes and Park, 1997). The guanxi network expands information and resource access by widening the sweep of environmental scanning for an organization and by linking with complementary assets in other organizations. On the other hand, economic studies view the organizational network as a connecting and transferring mechanism of complementary and interdependent competencies between firms. Teece (1986) emphasizes the importance of networks given the wide dispersion and strong interdependency of organizational and technological competence across firms. The transaction cost theory portrays the network as an intermediate form of governance between market and hierarchy, i.e., a specific type of bilateral governance based on transactional reciprocity. The network works as a device to mitigate the defects leading to failures of market and hierarchy by creating the principle of reciprocity. The long-term-based reciprocity incorporated within a network is an attribute of hierarchy, but networks also maintain the benefit of market efficiencies that flow from scale and scope economies. China’s recent economic transition has resulted in a high level of institutional uncertainty. Accordingly, transaction costs remain high for firms to secure necessary inputs and legitimize their existence. As such institutional uncertainty increases, firms more eagerly turn to guanxi networks to lower external dependence for key resources and improve their legitimacy. Thus, a guanxi network helps a firm overcome the lack of resources to accommodate growth while alleviating substantial bureaucratic costs that would result from internalizing operations. Furthermore, in China there is a substantial institutional hurdle in transferring ownership from one company to another, creating further needs for sharing through guanxi networks (Boisot and Child, 1988). As a loosely structured network, guanxi becomes an efficient mechanism to facilitate economic exchanges and overcome administrative interventions by the Chinese government. In fact, studies have indicated that a primary concern for Chinese managers and organizations is to engage in extensive

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networking activities through guanxi and various informal agreements for trust-building and favor exchanges (Kao, 1993; Tsui and Farh, 1997). Others have argued that organizational networks generate benefits through synergy and expanded market power (Powell, 1990; Thorelli, 1986). Networks provide each member organization greater access to human and financial resources, knowledge, and management expertise. In a collaborative relationship, member organizations can be thought of as chains of distinctive components. By specializing in its areas of core competence, while expanding the scope of the overall production function to encompass competencies of partner firms, each organization can achieve economies of scope through a reconfigured value chain. By linking together, organizations expand their product and market reach and exercise greater market power than freestanding competitors. Because market information is greatly distorted in a transition economy, the guanxi network becomes a reliable source for information necessary for their strategic decisions. Early adopters of network strategies may also enjoy “early fit,” providing opportunities to exercise greater political influence, establish standards for legitimacy, control valuable information, or broker new cooperative arrangements. Smaller or newer organizations can overcome legitimacy barriers through involvement in such networks, providing them wider opportunities for influencing local, political, or regulatory environments.

4.2 ORGANIZATIONAL DYNAMICS AND GUANXI The network literature addresses the diverse motivation for network creation, primarily economic, social, political, and institutional rationales. In a comprehensive review, Oliver (1990) identifies six organization-specific contingencies that are generalizable determinants of networking among organizations — necessity, asymmetry, reciprocity, efficiency, stability, and legitimacy. Guanxi utilization therefore depends on institutional, organizational, and strategic contexts unique to a firm. The intensity and nature of the guanxi depend on each firm’s idiosyncratic organizational and institutional attributes. Managers and firms seek out organizational connections and cultivate personal relationships to meet the specific needs

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for resources, political protection, or legitimacy, which otherwise would not be available to them. Given the lack of stable legal and regulatory environments, such connections are critical to managers and organizations in China to facilitate impersonal business activities (Alston, 1989). In particular, in China organizations receive different treatment and resource allocations from the government depending on their institutional and organizational orientations, such as ownership, size, experience, skills, etc. Therefore, there is a great deal of variation across Chinese firms in their institutional advantages and disadvantages (Nee, 1992). These organizational variations persist because they are deeply embedded in social, institutional, economic, and political systems. Firms are also idiosyncratic in their ability to scan information, handle information uncertainties, and benefit from information exchanges. They thus have different levels of need and capacity to utilize and sustain a guanxi network. Although guanxi is embedded in intricate and informal personal relationships, inter-partner complementarity in terms of strategic needs, organizational skills, and competitive strengths is still a necessary condition to cultivate and sustain the guanxi network. Network complementarity depends on specific organizational traits of the member companies. The resourcebased view posits that firms are heterogeneous with respect to their resource or capability endowments (Barney, 1991). Further, resource endowments are sticky over any strategically relevant time frame. Therefore, firms with heterogeneous and sticky resources or capabilities perceive differential opportunities and needs for guanxi networks. The mix of skills, knowledge, resources, environmental vulnerability, and institutional legitimacy depends on each member’s organizational and institutional attributes. Firm-specific settings thus determine the level of guanxi utilization and its influence on performance. Guanxi networks include connections with task environments and government officials. The guanxi network forms the lifeblood of the business community and the institutional context in China. Therefore, guanxi operates not only with other organizations in the task environment such as suppliers, buyers, and competitors but also with various levels of the government and regulatory authorities. In the absence of clear property rights, the extent of guanxi often affects decision-making by government officials. They exercise

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personal preferences in lieu of strict legal interpretations of rules. Instead of subscribing to the abstract notion of impartial justice, organizations may rely on personal contacts with government officials to get things done. For example, scarce resources are allocated according to guanxi rather than bureaucratic rules. Despite the ongoing economic reform to decentralize government control, the central government still controls resource distribution, investment size, industry structure, bank loans, and business formation in strategic sectors. Business activities still depend, to a large extent, on administrative interference rather than on the market mechanism. Accordingly, government officials maintain power to ratify projects, allocate resources and materials, arrange financing and distribution, and provide access to the infrastructure. Firms strive to reduce their quota specified in government contracts, so that they can generate extra profits by selling excess supplies in the market. Firms also attempt to secure supplies of key inputs through government channels at lower costs. Guanxi with officials also offers protection against environmental uncertainties.

Institutional Factors Ownership structure Institutions regulate economic activities through formal and informal constraints, and by setting the rules of the game as a basis for production, exchange, and distribution. Economic activities are shaped within the institutional framework because such a framework dictates which organizational actions are accepted and supported. Human and organizational interactions take place within the institutional framework. Accordingly, institutional frameworks place constraints on the firms’ strategic choices (Peng and Heath, 1996). Firms also react differently in adapting to institutional pressures. In China’s transition economy, institutional impacts are manifested in ownership structure and location of the firm. Despite ongoing endeavors to facilitate market transactions, China’s economic reform remains incomplete, with both plan and market systems operating in the economy. There is a great deal of ambiguity regarding

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property rights, and production factor markets are inoperative, which is why survival of firms largely depends on their networking with local governments. Private firms have grown quickly, while control of financing and key scarce resources largely remain with the state, and since the early 1980s, allocations have been restricted to private firms. The ambiguity in property rights has generated a new form of opportunism amongst entrepreneurs and state and local governments. At least until the early 1980s, state or local governments maintained full control over the redistribution of capital and important raw materials. Private firms have to compete with state-owned firms for scarce resources. It is not surprising to find private firms often going out of business for lack of materials even if they have products popular in the market. They lack legitimacy and political backing to secure access to capital, which forces them to turn to private resources and to pay much higher rates. Private firms also face a great deal of political uncertainty. Their survival depends on the unreliable market rules of the game set by the government. Given such institutional uncertainty, private firms have to nurture a longterm-based reciprocal relationship with local governments through various formal and informal ties, i.e., guanxi, in order to economize on transaction costs. Chinese firms often settle negotiation deals through reciprocal personal connections, i.e., guanxi, which are also backed by local governments. China’s transformation has thus given rise to a distinctive institutional form called “network capitalism” (Boisot and Child, 1996). As the number of non-state-owned firms exploded during the 1980s, state-owned firms started practicing the “contractual liability lever” in their management and reward systems. Facing the ineffective factor markets and ambiguous property rights, the guanxi network substitutes for government-instituted, formal channels of resource allocation and dispersal. Thus, non-state-owned firms are more likely to form guanxi than the state-owned firms.

Location Favorable location becomes a source of competitive advantage for incumbents if they can acquire the location at a price less than its true value (Barney, 1996). During the economic reforms of the 1980s, the Chinese government

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established special economic zones in a bid to lure foreign direct investments (FDIs). These areas offer various benefits to incumbents, like low-cost labor, tax exemptions, and duty-free importation of raw material and technology. Infrastructure support and investment incentives in these areas offer lower operating risks and higher efficiency and returns for incumbents. These are also attractive host locations for foreign firms and investments and they are centers of market-oriented growth, leading to strong competitive incentives. For these reasons, there is wide variation in the level of economic development and the stage of economic reform across regions, especially between the open and non-open economic regions. Accordingly, these regions reflect differences in cultural environments, business atmosphere, and government policies. Open areas, such as special economic zones, generally maintain more Western-style business facilities and cultural atmosphere than nonopen areas. Therefore, organizations in open areas tend to rely more on arms-length transaction relationships than those in non-open regions, due to the enhanced market competition among organizations. On the other hand, non-open regions experience much lower level of inter-firm competition and reflect a stronger collectivistic tradition than the open regions. In non-open regions, firms maintain a much stronger tendency of collaboration with other firms and government officials to overcome any impending disadvantages in competing against those in open regions. Due to the less preferential treatment from the government, such as taxation, financing, and resource allocation, the firms in non-open regions are pressed to rely more on guanxi connections to compensate for these constraints and disadvantages in the institutional environments. Therefore, organizations in less open economic regions are more likely to develop guanxi networks with the business community and government authorities.

Strategic Factor Strategic orientation The strategy field presents numerous classification schemes to illustrate the dimensions of business strategies (Porter, 1985). The configuration approach

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characterizes firms according to a few sets of organizational and strategic orientations. Several typologies such as Miles and Snow (1978), Porter (1985), and Miller and Friesen (1983) represent the configuration approach. These strategic configurations similarly focus on the relative emphasis a business puts on market effectiveness versus operational efficiency. For example, the Miles and Snow framework distinguishes business strategies into three distinctive types — defenders, prospectors, and analyzers, while Porter includes overall cost leadership and differentiation according to a firm’s relative focus on market effectiveness and operational efficiency. The strategic orientation toward market effectiveness, for e.g., prospector or differentiation, continuously searches for market opportunities and experiments with emerging trends and technologies. Firms following a marketoriented strategy concentrate on scanning, identifying, and capitalizing on emerging market opportunities and value being “first-in” in new product and market areas. They also bear high costs and risks in maintaining extensive and flexible capabilities to respond to institutional and economic changes in a given market. Managers in market-oriented firms choose from a wide variety of options and emphasize exploring novel ideas and strategies and try to respond rapidly to early signals of opportunities in dynamic markets. Therefore, market-oriented firms face a much greater probability of failure and a higher level of outcome uncertainty as they explore new options. In sum, a market-oriented strategy reflects the availability of multiple options, low behavior programmability, high cause-effect ambiguity, and outcome uncertainty. Market-oriented firms may thus be in greater need for the guanxi network to mitigate the outcome uncertainty and risk posed by an innovative and aggressive strategic orientation. They also emphasize communicating with local markets and spanning boundaries to accommodate dynamic changes and the needs for expansion as they strive to identify and capitalize emerging market opportunities. The higher level of uncertainty posed by the transition economy further forces market-oriented firms to seek guanxi to deal with competitive forces in the task environment and government officials. Market-oriented firms can minimize uncertainties and secure necessary inputs through guanxi networks. In contrast, the efficiency-oriented strategy, for e.g., defender or overall cost leadership, is rigid, shortsighted, non-adaptive, and risk-averse.

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Efficiency-oriented firms tend to focus on increasing the efficiency of existing operations through continuous improvements. These firms often develop cost-efficient single-core technologies and seldom adjust their internal orientations. While the market-oriented strategy enacts dynamic environments and builds the prime capability in finding and exploiting new product and market opportunities, the efficiency-oriented strategy strives to efficiently serve stable and narrowly defined products or market domains (Miles and Snow, 1978). Because efficiency-oriented firms emphasize operational efficiency, they tend to ignore environmental changes that have little impact on their current operations. This type of strategic orientation is basically an internally oriented approach with little attention paid to external changes or opportunities. Overall, the efficiency-oriented strategy reflects restricted managerial options, more emphasis on historical precedents and programmability, less cause–effect ambiguity, and less risk and outcome uncertainty. Therefore, these firms face little need for guanxi and network building with external competitive forces or government officials. Moreover, during the recent economic transition, guanxi cultivation has become very costly, because of the paying of “management fees” to government officials to secure political protection and reliable access to scarce resources. This further discourages efficiency-oriented firms to pursue guanxi. As a result, organizations are more likely to utilize guanxi networks as their emphasis on market-oriented strategy increases.

Organizational Factors Organizational size Size is an important firm attribute that shapes behaviors and decisions. With increased size, bureaucratic structures emerge and it becomes difficult to employ a personal, entrepreneurial style of management. Shan and Hamilton (1991) present empirical evidence that small firms are more likely to cooperate with others than large firms. Small firms look for external support to enhance environmental scanning and overcome the lack of key resources and technology. Managers from large organizations are also less inclined to adopt participate managerial attitudes, while those from smaller

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organizations are more flexible in decision-making. In general, size affects organizational culture, ownership structure, and agency relationships. Size also affects a firm’s capability in handling the task environment. Large firms are able to maintain favorable access to capital. Hall and Weiss (1967) also show a positive relationship between absolute firm size and profitability due to enhanced scale and scope efficiency. In China, most large firms are the descendants of the old planning system. Prior to the reform, it was the state government that determined the scale of a firm. Size has a direct link with management’s perks and status and there is a precise correspondence with the government hierarchy. Besides the lack of support from the government, small firms in China also have little bargaining power over the government, making them subject to frequent government intervention and hindrance. Given government protection, large firms in China lack competitive and entrepreneurial mindsets, with little incentive to cultivate guanxi with other competitive forces in the task environment or government officials. Xin and Pearce (1996) assert that in China small firms place greater stress on the importance of personal and organizational connections with external stakeholders to counteract these liabilities due to smallness. Establishing guanxi with government officials becomes critical for the survival and growth of small firms in China, allowing them to overcome these institutional disadvantages. The population ecology literature addresses the direct negative relationship between size (and age) and organizational survival due to the lack of external ties and legitimacy. Organizational survival and performance thus improve as a firm gets bigger. Guanxi networks become a primary mechanism for small firms in China to overcome the liability of smallness and other competitive disadvantages. Small firms do not have the necessary organizational capabilities to compete against big firms. Rather, small firms have competence in strategic and operational flexibility. They maintain an entrepreneurial spirit to easily cultivate guanxi networks and offset such institutional and competitive disadvantages. In sum, while small firms face more desperate needs for external buffers against such liabilities, the smallness allows them to be more flexible in adapting through guanxi cultivation. Consequently, small organizations are more likely to utilize a guanxi network than large organizations in China.

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Resources The resource-based view posits that sustainable competitive advantage stems from the valuable, rare, and inimitable resources firms develop over time (Barney, 1991). Technological skills and managerial capabilities are particularly relevant for guanxi development in Chinese firms. Technological skills constitute a predominant element of organizational competence. These skills allow an organization to develop new products and processes and the potential to adapt to changing market dynamics. The resource dependence framework suggests a lower level of external dependence for the firms with superior resources and capabilities. This further indicates that firms have lesser needs for guanxi networks as their technological skills improve. In a transition economy, superior skills also give strong bargaining power to the firm with the government whose primary goal is fast economic development. Firms with superior technological skills thus have little need for connections with government officials and regulatory agencies. In fact, building guanxi is an over-investment for this type of organization. Instead of external networking, Prahalad and Hamel (1990) indicate that the firm with superior technological skills tends to maintain a higher level of technological interdependence within the firm itself. Internal networking improves scopebased economic gains by leveraging the skills across its own business units while preventing the potential leakage of the capabilities to competitors. On the other hand, in China, firms with poor technological skills utilize guanxi as a competitive instrument to overcome this competitive disadvantage by securing deals from suppliers, orders from buyers, and approvals from the government. Given inoperative factor markets and ambiguous property rights, the guanxi network appears as an economically and culturally viable mechanism to offset technological disadvantages. Thus, organizations with poor technological skills are more likely to utilize a guanxi network than would those with superior technological skills. Managerial skills are important capabilities toward building organi­ zational competence; they are difficult to imitate because they are scarce, specialized, and tacitly embedded within a firm. As the transition toward a market system continues, there is an increasing need for effective

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managerial capabilities that are still rare resources in China. Managerial skills are embedded in complex social systems and involve various social and cognitive processes that are not yet well understood. Due to its specificity, managerial skills are difficult to transfer to other organizations or to imitate, bestowing sustainable competitive advantages on a firm. Given that the guanxi network is a substitute for competitive disadvantages, Chinese firms with superior managerial capabilities may have relatively lesser need to utilize it. Previous studies report that Chinese firms lacking managerial skills tend to pursue more guanxi-based business strategies such as sales force marketing and credit liberalization in purchasing (Luo and Chen, 1996). In China, direct personal marketing is primarily a reflection of guanxi contacts. Sellers would try not to embarrass customers who are temporarily unable to pay in a culture where the guanxi is painstakingly nurtured and harmony is upheld as a high priority. On the other hand, organizations with strong managerial capabilities tend to develop guanxi-free business strategies such as advertising, internal R&D, pricing, product or service quality (Luo, 1997b). As a consequence, organizations with poor managerial capabilities are more likely to utilize a guanxi network than would those with strong managerial capabilities.

Length of operation Organizational history is also an important determinant of legitimacy, strategic behaviors, and guanxi cultivation. History shapes organizational culture by affecting values and beliefs that develop over time. Organizational age reflects institutionalized managerial attitudes and beliefs. The population ecology theory assumes that inertia is a prevailing property of organizational evolution and that, consequently, organizations retain basic attributes of their early forms (Hannan and Freeman, 1989). Young organizations are subject to the liability of newness because routines are rarely perfected and stabilized, organizational politics are unstable, and links with key actors in the environment are irregular. It takes time for an organization to acquire institutional legitimacy among its network members and to become valued in its own right. On the other hand, older organizations are also highly

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entrenched with bureaucratic rules and systems and lack entrepreneurial values to dynamically adapt to environmental changes. New organizations, therefore, need to be more proactive and aggressive in searching for external resources that are essential for their survival and growth. Also, young organizations in China, particularly those formed during the recent economic reform, are more entrepreneurial than older organizations; they are primarily based on market-based incentive systems and follow tightbudget constraints. These newer organizations are flexible in choosing the right modes of operations to adapt to market needs, whose main goal is to maximize profits instead of serving society like older, state-owned firms. Therefore, we expect stronger and more active guanxi utilization by newer organizations in China to overcome the lack of legitimacy and competitive resources. Guanxi also offers the newer firms risk-reduction capability. Therefore, newer organizations are more likely to utilize guanxi networks than older organizations in China. In conclusion, guanxi is an important cultural and social element in Chinese society with significant effects on business operation, survival, and growth. Guanxi has been developed over many centuries. It reflects highly complex social phenomena that are embedded all personal and organizational interactions. Despite the wide utilization of guanxi, there is a noticeable difference among Chinese firms in the utilization of guanxi. Institutional, strategic, and organizational factors characterize the setting for guanxi development. These factors determine the extent of needs and capacity for guanxi development. Recently, Luo and Park’s (2001) analysis provided strong support for a framework indicating all three constructs as critical antecedents to guanxi development in China. An unexpected finding from this study is the insignificant role of organizational factors in the development of government guanxi. Guanxi networking with government officials and authorities seem to depend primarily on the institutional and strategic factors of a firm. Guanxi with competitive forces such as suppliers, buyers, and competitors, however, can be attributed to all factors, including institutional, strategic, and organizational factors. A firm’s possession and control of important resources determines the extent of its external dependence. For example, organizations with

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advanced skills and resources have less dependence on guanxi connections. Repeated interactions in a guanxi network lead to a socially embedded relationship demanding continuous commitment from all parties. On the one hand, the personal attachment that develops over time, mainly among executives, constitutes a social asset that enforces the continuation of the guanxi connection. Such attachments make guanxi sustainable, transferable, and intangible and attenuate difficulties due to uncertain changes in the environment. On the other hand, however, the attachment becomes inertia that operates against implementing internal changes to spur efficiency enhancement. Guanxi emerges over time as a social, relational asset that promotes sales growth, but not necessarily profit growth. Economic motivations in guanxi development become diluted or offset as the connected parties stick to the reciprocal norm and attempt to sustain the network at any cost. Figure 4.1 sums up the relationship between organizational dynamics and guanxi utilization.

Institutional Factors • Ownership • Location

Strategic Factors • Strategic Orientation • Industrial Experience

Organizational Factors • Size • Resources • Length of Operations

Legitimate Guanxi

Firm Performance

Figure 4.1. Guanxi and organizational dynamics.

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4.3 EMPIRICAL EVIDENCE Luo and Park (2001) conducted a mail survey with high-level managers, such as general managers or deputy general managers, between 1996–1997. The data set includes companies from multiple industries located in southern China, mainly Shanghai and Jiangsu provinces. According to the analysis of the data containing 128 responding firms, the following findings are reported. First, the correlation matrix indicates consistently significant correlation between the antecedent variables and business guanxi networks. Except for length of operation, every independent variable is significantly correlated with guanxi with the business community. However, only institutional factors, i.e., ownership structure and location, and strategic orientation are significantly correlated with the guanxi network with government authorities. None of the organizational factors are significantly correlated with guanxi with government authorities. The two types of guanxi (guanxi with other businesses and guanxi with government officials) appear to be closely related to each other indicating that as companies build external networks, they do so with both the forces in the task environment and institutional authorities. Second, institutional factors, i.e., ownership structure and location, are consistently significant for both types of guanxi. Ownership structure shows a stronger relationship with guanxi with government authorities while the relationship reverses for location, with a stronger relationship with guanxi with business community. These results are consistent with theoretical implications. Non-state-owned firms attempt to build connections with government authorities in order to mitigate transaction costs and uncertainties due to ambiguous property rights. Non-state-owned firms need institutional support and protection to secure access to key inputs and buyers. But companies in relatively closed locations will attempt to overcome institutional disadvantages through direct connections with buyers, competitors, and suppliers. Third, strategic orientation, i.e., the level of market effectiveness, is significant for both types of guanxi. These results indicate that companies which oriented toward market effectiveness are more likely to pursue guanxi networks because their focus is on market penetration and quick adaptation to changes in buyer needs and other competitive forces. None of the

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organizational factors are significant for government guanxi while most of them are significant for business guanxi. This is consistent with indications in the strategy literature that companies build networks with competitive forces in the task environment to overcome organizational disadvantages. These companies, however, have little need for networks with government authorities. As predicted, size and resources are negatively related with business community guanxi but are not associated with governmental guanxi. This may indicate that companies in China need active networking with government authorities, both to overcome the liability of newness and to ensure the survival and growth of older firms. In a transition economy with increasing competition and decreasing government protection, older firms may still need to invest in guanxi development with government agencies to continuously offer and exchange favors with numerous constituencies they have developed over time. Young firms may utilize guanxi intensively while older firms use it more extensively. Overall, the results indicate different patterns of guanxi development across firms according to institutional, strategic, and organizational settings. These firm-specific factors also affect the type of guanxi networks firms pursue. The weak support for organizational factors as antecedents to development of government guanxi, however, does not imply that managers with strong resources do not use government guanxi. It may rather infer, as supported in our field study, that firms in China develop and maintain good connections with government authorities regardless of resource conditions. This is consistent with earlier findings that institutional uncertainties and ambiguous property rights necessitate good networking with various government agencies for most firms in China. In conclusion, guanxi is an important cultural and social element in Chinese society with significant effects on business operation, survival, and growth. Despite the wide utilization of guanxi, there is a noticeable difference among Chinese firms in guanxi utilization. Organizational traits determine the extent of needs and capacity for guanxi development. Guanxi networking with government officials and authorities seems to depend primarily on the institutional and strategic factors of a firm. Guanxi with competitive forces, however, can be attributed to all factors, including institutional, strategic, and organizational factors. Guanxi has been developed in China over centuries.

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It reflects highly complex social phenomena that are embedded in every part of personal and organizational interaction. Yeung and Tung (1996) conducted a survey in China and found the following results relating to the influence of organizational attributes on guanxi utilization. First, those with ten or more years of experience assigned a lower priority to guanxi than did those with less experience. Years of experience is a reflection of the age of a business’s establishment in China. Guanxi is of paramount importance in the initial stages of entering the China market. Beyond a certain threshold level, however, other factors assume greater significance. Second, small- and medium-sized firms tend to place greater emphasis on guanxi than do large companies. Since large firms can contribute substantially to the local economy, Chinese authorities are keen to attract their investment in the first place.

4.4 PRACTICAL EXAMPLES Minicase 1: Does Guanxi Matter in KFC? KFC started in 1956 when founder Harlan Sanders started franchising his concept of “southern fried chicken.” By 1964, he had almost 700 franchises at which time he sold the business while still retaining an active role in product promotion and quality control. This was followed by a massive period of growth averaging 96 percent per year. In 1971, Heublin Inc., a spirits company, bought the company. During this period, KFC first started to open stores overseas in Japan, Hong Kong, the UK, and South Africa. In the mid-seventies, the company started encountering problems because of increased competition in the US and poor relations between country managers and local staff. Michael Miles revamped the company with a QSC plan (quality, service, and cleanliness) policy. As a result, by 1982, the company had improved greatly and tobacco giant RJ Reynolds purchased the company. This meant a substantial increase in financial backing, including a US$1 billion global expansion plan for the next five years. In 1983, KFC had established 85 franchises in Southeast Asian countries such as Indonesia, Malaysia, and Singapore. In 1985, KFC returned to

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Hong Kong after a ten-year absence and achieved great success. This lead to consideration of entering the huge untapped China market under the leadership of Wang Ta-Tung, a former executive of KFC and an overseas Chinese.

Operations in China? Wang had already achieved great success in a restaurant joint venture in Tianjin and applied this knowledge as head of operations in Southeast Asia and China, beginning in 1986. After considering Tianjin, Shanghai, and Guangzhou, Beijing was chosen as the first city of entry. This was because of Beijing’s high level of affluence and intellectual enlightenment. In addition, there are many tourist sites that attract a lot of foreign visitors and thus more FEC. The Beijing location was so successful that within four months it became the highest-selling KFC in the world. In 1987, the largest KFC in the world opened at Tiananmen and was even more successful. It opened with much fanfare and speeches by the US ambassador, the mayor, the chairman of KFC, and other dignitaries. The restaurant was a tremendous success and the need quickly arose to open many more branches in the city. This was a public relations victory because it demonstrated that the Chinese government approved of KFC enough to open a huge restaurant in Tiananmen, the heart of the Chinese government. The general manager for the Beijing–KFC operation was Sim Kay Soon, a Singaporean who reported to the director for China, Daniel Lam, from Hong Kong. Much of the rest of the local management was from a similar background and considered a Beijing assignment to be a hardship.

Minicase 2: Why is Shanghai Volkswagen Successful? In October 1984, a joint venture was signed between Volkswagen AG (VW AG) and a consortium of Chinese partners led by the Shanghai Automotive Industrial Corporation (SAIC), the Bank of China, and the Chinese National Automotive Industrial Corporation (CNAIC). The agreement, valued at RMB 1 billion, established a 25-year Sino–German partnership with 50 percent

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equity provided by VW AG, 25 percent by SAIC, 15 percent by the Bank of China, and ten percent by CNAIC. Initial equity raised by the partnership would be used to finance the renovation of production facilities, to import production lines from Brazil, and to import the Santana CKD’s (complete knockdown). The new joint venture was called Shanghai Volkswagen (SVW). As the second automobile joint venture in China, they planned to manufacture automobiles and engines and were granted special tax relief under Chinese guidelines for advanced technology partnerships: a standard two-year tax holiday and a special six-year tax rate exclusive to SVW in exchange for the promised technology transfer. Senior management responsibilities were divided between a Chinese managing director and a VW-appointed expatriate deputy managing director. The remainder of the board reflected the equity contributions of the Chinese and German partners. The problem of foreign exchange was solved through a counter trade agreement in which VW AG agreed to purchase engines produced in Shanghai to be used in cars manufactured in Europe. Earnings from such exports would support the use of foreign currency by SVW for importing the kits, and later the foreign components, used for assembly in China. Penetrating the Chinese car market fit with VW AG’s Asian strategy. In 1990, VW AG signed its second joint venture in China with First Automobile Works in Changchun. The two Chinese plants, along with a third located in Taipei, formed the vertices of the “Chinese triangle”; three production facilities for VW AG from which it would distribute and sell cars to the Chinese market. By 1995, SVW was able to deliver 88 percent of the value of the automobile from China-based factories, thanks to an extensive array of domestic and FIE suppliers. SVW’s passenger cars had established a 47 percent market share and, including sales of Jetta and VW AG, amounted to 58 percent of all locally produced cars in China. The original factory produced 115 326 cars and 120 000 engines, and the Shanghai JV planned to produce 160 000 cars by 1995. This was a giant leap from only 1733 CKD cars assembled from kits in 1985. In 1994, the Santana was priced at US$20 000, which was much cheaper than imported cars that had duties up to 200 percent.

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In 1995, SVW introduced the Santana 2000, with new exterior styling. Annual production of both Santana models reached 159 766 units in 1995. However, new requirements for new models and part updates were not easily met by local suppliers without a great deal of technical support from VW AG or a Western parts manufacturer. Nevertheless, SVW had started out being locally sourced: 60 percent by 1990 and by the end of 1995 close to 90 percent. This was an amazing accomplishment because, in 1986, Chinese automobile component suppliers were nearly 30 years behind the West. A fundamental shift was required in parts design and in technology. SVW was successful because it took an all-encompassing approach to solving the problem; including well-organized management, market strategy, quality, training, flexibility, and the establishment of good guanxi with competent suppliers. In addition, in closely following the government’s directives to establish R&D infrastructure and to localize as much as possible, it became highly competitive in the China market. 1. Market Strategy: SVW chose the Santana because market research had indicated a strong Chinese preference for sedans. Secondly, the sturdy construction of the Santana could withstand the harsh conditions on China’s sporadically maintained roads. 2. Management: Three departments managed relationships with suppliers. First, the product-engineering department specified the technical details such as tolerance necessary for the incorporation of a part within the Santana. Second, the supplies department coordinated purchasing and commercial affairs between suppliers and the SVW. Third, the quality assurance department sought feedback from the shop floor and from customers to relate to suppliers. SVW also attempted to introduce JIT delivery and the concept of lean production. Lastly, the central office, to manage the local parts content development program, was located in Beijing in order to avoid conflicts of loyalty between the two factory locales. 3. Quality: Prospective parts suppliers were subjected to a localization protocol to ensure ongoing quality control. Quality testing in the localization protocol included functional basics such as dimensions, strength, and durability. SVW categorized its suppliers into A, B, or C classes: A suppliers produced parts worthy of export; B supplied parts worthy of the domestic

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market; and C suppliers were not even worthy of the domestic market. A company’s classification could change from year to year depending on performance. As a means of positive reinforcement, SVW was willing to pay a purchase price capped at the price of a similar import plus custom duties. In addition, it guaranteed a profit for every manufacturer in its parts supplier network. SVW also formed the Santana Localization Community in which yearly “quality conferences” were opened to broaden communications between suppliers and SVW. 4. Training: New manufacturing hires were given a three-year training course which included classroom lessons and practical training in machinery, welding and forging. Training for secretarial and sales staff lasted two years and included lessons in accounting and bookkeeping. SVW actively sponsored adult education in night school programs. 5. Flexibility: The government, at times, interferes with aggregate production planning. For example in 1989, SVW was ordered by the central government to produce 15 687 cars, even though it had originally planned to produce 20 000. As a result, SVW shut down for 39 days to reduce production. In this way, SVW has to be flexible and be able to react quickly to unpredictable government actions. 6. Guanxi: The advantage of having Chinese partners is that they brought an understanding of their society and recommendations on how to be most efficient in that environment. This became a useful tool when the emphasis on the parts supply network gained an added measure of urgency, when a timetable for growth in the percentage of localized components was written into the joint venture contract. In order to improve the quality of Chinese suppliers, SVW first encouraged Chinese suppliers to forge cooperative relations with peer parts makers from abroad. The second step was to send key engineers, from the Chinese suppliers, overseas to train with their foreign counterparts. In order to find the best partners possible, spot checks of prospective suppliers were conducted to evaluate their manufacturing capabilities; suppliers were scored on the technical level of their workforce and equipment, and the quality of products currently in production. To expedite the localization process, VW AG pursued vendors whose products paralleled those required by VW AG. They worked simultaneously in contacting their European suppliers, trying to get them interested in coming

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to China to manufacture their parts. SVW would provide lists of possible Chinese partners to Western companies and facilitate the introduction process between the Chinese and European companies. In conclusion, SVW succeeded because it took a long-term and thorough approach to producing cars in China. In particular, its stubborn pursuit of quality at all levels ensured quality products and maximum production efficiency. Its persistent efforts to localize served a dual role of lowering the costs of production and gaining the support of the national government. This was exactly the kind of operation the Chinese government was looking for and evidence of this can be seen in the fact that Deng Xiao Ping, Li Peng, and Jiang Ze Min have all visited the factory. Such success along with a willingness to cooperate with government policy will surely lead to favorable treatment in the future by the government. Being a low-cost yet high-quality sedan, Santana is well suited for the China market. Lastly, SVW’s very aggressive stance toward entering the China market, by achieving 90 percent localization within ten years, meant that it would enjoy both first mover and cost-leader advantage over virtually all the other competition.

Minicase 3: Caterpillar Tracks a Wayward China Path How do you put a value on guanxi, the connections that grease the wheels of business in China? Caterpillar spent about $700 million last year to buy Hong Kong-listed Chinese mining-equipment company ERA Mining Machinery. Ten days ago, the U.S. company alleged accounting fraud at the Chinese business and wrote off most of the value of its acquisition, knocking about 9% off earnings per share for 2012. Caterpillar says it was misled by deliberate misconduct intended to overstate ERA’s profitability prior to the acquisition. But what was Caterpillar buying anyway? A cursory look through ERA’s accounts during the due-diligence process must have thrown up red flags. The target appeared headed for a working-capital crisis. Customers owed more than a year’s worth of revenue, as accounts receivable jumped 37% between 2010 and 2011. That outpaced sales growth of just 10%. The

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value of inventory not yet shifted out to customers increased 234%. At the same time, ERA’s operations were burning cash. As China’s economy slowed, the situation worsened. ERA’s own directors loaned money to the business — usually a governance alarm bell — to keep a lid on expensive financing costs. And in March last year, ERA warned it would miss a profit target because of rising raw material and financing costs and a ballooning allowance for bad debts. Sure, ERA may have been growing fast, building relationships, developing sales channels, getting customers and the government to trust its safety-focused products. But its model was unsustainable. Sales were boosted only by extending credit and better terms to Chinese customers in order to compete with state-owned rivals. That was stretching working capital to its limits. A takeover was the only way to avoid deeper trouble. A big buyer — more established and with a far meatier balance sheet — could get better financing terms and also reduce cost inefficiencies. Caterpillar could build on the relationships, and guanxi, that ERA had already developed. That plan, though, isn’t working out. Alleged accounting misdeeds have thrown a wrench in Caterpillar’s works. But profiting from guanxi built on a clearly unsustainable business model was always going to be tough. For Caterpillar, China has long proved difficult to crack. Its massive write-down on the ERA deal shows that is still the case. Source: Adapted from “Caterpillar Tracks a Wayward China Path”, Mavin, Duncan. Wall Street Journal (Online); New York, NY, 29 Jan 2013: C. 10.

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5 GUANXI-BASED BUSINESS STRATEGIES

The ultimate realization of guanxi potential depends upon the application and operation of several business variables in which guanxi is embedded, since business activities are where guanxi can best play its role. This chapter first illustrates what the guanxi-embedded business strategies are. The second section proposes and tests the influence of guanxi-based business determinants on firm operations. The managerial and practical implications of guanxi-based business strategies are offered next, followed by a section on guanxi between organizations. The last section provides several practical examples indicating how firms utilize such business strategies in pursuit of their strategic objectives.

5.1 GUANXI-BASED BUSINESS STRATEGIES As noted earlier, guanxi provides the lubricant for the Chinese to get through life and it heavily influences Chinese social behavior and business conduct. Since China began economic reform and opened the door to the outside world in 1979, guanxi has become even more important. Today, guanxi hu is an everyday word used when speaking of business firms that maintain extensive guanxi with one another and give each other preferential treatment. It is important for firms that lack marketing experience, distinctive competencies, or distribution channels to cultivate guanxi in order to compensate for their deficiencies. Eventually, they can build a guanxi network of their own, which will help them gain access to and expand their local market. In other words, a firm can enhance its performance by benefiting from the guanxi

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network it has established. In essence, this network constitutes a firm’s core competency and distinctive competitive advantage that can lead to high performance for the firm. The ultimate realization of guanxi potential depends upon the application and operation of several business variables in which guanxi is embedded. In strategic management literature, a variety of business strategy variables are observed to impact firm performance. The most commonly analyzed business strategy variables include firm size (Hall and Weiss, 1967), pricing (Gallego and VanRyzin, 1994), advertising (Chauvin and Hirschey, 1993), and R&D intensity (Hoskinsson and Johnson, 1992). Among these variables, however, firm size and R&D intensity are deemed not relating to guanxi, because they represent the firm’s economy of scale or product differentiation and do not rely on contributions from other organizations (guanxi hu) or people outside the firm. In a similar vein, advertising and pricing are also not likely to be tightly and significantly associated with guanxi, since the outcome of these two variables is predominantly determined by the firm’s own strategies or policies. On the other hand, Chinese management studies have observed that sales force marketing and credit liberalization are important practical business determinants (Luo and Chen, 1996). A primary reason for the importance of sales force marketing and credit liberalization to the firm’s performance, this study claims, resides in the latent linkage between these two business variables and guanxi. Sales force marketing, an activity heavily dependent on guanxi and usually relying on partner firms (guanxi hu), has become an increasingly popular and effective marketing means. Three forms of sales force marketing can be distinguished: direct dispatching of marketing personnel; setting up regional sales offices in major target areas; and selecting sales representatives from outside the firm on a commission basis. In either case, guanxi is fertile soil where direct personnel marketing can flourish. Even though a sales person may initially lack a direct guanxi network, he or she can use the members of his or her indirect social network, such as classmates, friends, and colleagues, to promote products. Guanxi-based personal selling can produce impressive marketing results even when the product’s attributes are not competitive.

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Another major guanxi-based business variable is credit-extension in commercial activities. This credit-granting practice is, at least to some extent, a reflection of culture. In a country where guanxi relationships are painstakingly nurtured and the maintenance of harmony is of paramount importance, sellers would do their utmost to avoid embarrassing customers who may be temporarily unable to pay. For buyers, those who have maintained more extensive guanxi networks in purchasing activities are likely to have a higher intensity of accounts payable and accordingly gain more from extension of commercial credit. For sellers, those who have maintained a better guanxi network in marketing activities are expected to achieve a higher performance in terms of domestic sales growth. In sum, the above conceptual illustration suggests that sales force marketing and credit liberalization are two major guanxi-based business variables, whereas other business variables such as firm size, R&D intensity, advertising, and pricing are not guanxi-based. In order to verify the construct validity of this classification, we conducted a simple survey in Suzhou, Jiangsu province, in February 1995. The questionnaires were distributed to participants of an advanced management seminar held in Jiangsu. Each of these managers was asked about the scale (5-point) of each business variable’s involvement with guanxi (5 = very high, 1 = very low). Sixtyseven responses out of some 100 managers were returned in usable form. Table 5.1 reveals a summary of survey results. Table 5.1.  Summary of survey results. # * ,

Number of Responses Business Variables

Scale

1

2

3

4

5

Sales Force Marketing

—

—

—

—

8

59

Credit Liberalization

—

—

—

3

12

52

Pricing

—

15

34

12

4

2

Advertising

—

14

39

8

5

1

R&D Intensity

—

28

30

7

2

—

Firm Size

—

49

18

—

—

—

#5-point scale (from very low to very high) measurement of business variable’s involvement with guanxi (N = 67). *Effective reliability R = 0.812. est

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Consistent with our above proposition, it is apparent that sales force marketing and credit granting have the highest level of involvement with guanxi whereas other business variables have a fairly low level of involvement (see Table 5.1). More specifically, an overwhelming majority of respondents (over 95 percent) view sales force marketing and credit granting as having a high involvement with guanxi while very few respondents (less than nine percent) think other business variables have such a high involvement. The effective reliability of the survey measurement appears to be reasonably high (R = 0.812). In theory, guanxi-based business practices offer certain transaction cost advantages over existing structural alternatives identified in trans­ action cost theory. Where the guanxi network is well developed, the transaction cost advantages of reduced opportunistic behavior are enough to warrant the integration of guanxi- and market-based exchange mechanisms. Under such conditions, the significance of guanxi will not diminish as predicted even with the transformation to a more market-based economy. Instead, moderately asset-specific activities will continue to be performed via the guanxi network while less asset-specific functions will be performed through market-based exchange.

5.2 IMPACT OF GUANXI-BASED BUSINESS STRATEGIES As stated above, sales force marketing relies highly upon guanxi networks and can benefit from the preferential treatment furnished by guanxi hu. As a result, guanxi-based personal selling can produce high performance with regard to local market growth for ventures. In some cases, where a firm’s product attributes are not competitive vis-a-vis rivals, a good guanxi network can even offset the disadvantages of poor product attributes. In fact, if a buyer does not purchase the goods sold by its guanxi hu, he or she will break up the guanxi relationship and lose his or her “face” (mianzi). Therefore, driven by dynamics of maximization of sales commissions, a form of compensation widely used in China today, sales force marketing is expected to have a significant and positive effect on domestic sales growth. Accordingly, the total asset turnover (sales/total assets) is also likely to be higher, given the same amount of assets.

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As noted earlier, although guanxi brings obligations and costs (renqing) to its beneficiary, these are mainly social obligations. Moreover, the marginal costs to develop and nurture guanxi, compared with the corresponding marginal benefits in personal selling activities, are exceedingly low. Therefore, the marginal contribution of sales force expenditure to accounting return is usually greater than unity. In view of the above, it is predicted that, ceteris paribus, the intensity of sales force expenditure has a significantly positive effect on a firm’s sales growth, asset turnover, and profitability. Another major business strategy variable highly involved with guanxi is credit-extension in business activities. In practice, a liberal credit policy is reflected in preferential terms of payment and, in particular, temporal extension of payment deadlines. As stated earlier, when seeking market growth, selling firms in China tend to avoid embarrassing those buyers with financial difficulties since one principle of guanxi requires the maintenance of harmony and providing assistance to those partners who need help. In recent years, many businesses have experienced liquidity problems as a result of the tight monetary policies implemented by the authorities. Under these circumstances, those buyers who have maintained more extensive guanxi networks in purchasing activities are likely to have a higher intensity of accounts payable and accordingly gain more from the extension of commercial credit. It is suggested that this benefit is reflected in a higher asset turnover for the buying firm as a whole (not deal-specific). The benefits from the economics of accounts payable are possibly conducive to a higher accounting return. However, to make guanxi work in the long run the buying firm must honor its obligations, remain loyal to its guanxi hu, and maintain a reputation for reliability. This means that the buyer must keep his or her commitments (even oral) in timely payments and cannot expect continuous extension of commercial credit from the guanxi hu. As a consequence, no significant relationship can be expected between the intensity of accounts payable and the firm’s cross-years profitability. Therefore, it is predicated that, ceteris paribus, the intensity of accounts payable has a significantly positive effect on a firm’s asset turnover. The other side of credit granting, the intensity of accounts receivable for the seller, is also tightly associated with guanxi. According to the reciprocity principle of guanxi and the essence of mianzi, after having

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secured Commercial credit from the seller (guanki Lu), the buyer is expected to purchase more from the same firm. This reciprocity principle constitutes the rationale for maintaining a long-standing guanxi web. As a result, it is predicated that, ceteris paribus, the intensity of accounts receivable has a significantly positive effect on a firm’s sales growth. With the unprecedented economic development and the modernization which is taking place in many Chinese societies — most visibly on the mainland — guanxi is under increasing pressure to change and adapt. Gradually, Chinese will have to reconcile their guanxi networks with the inescapable dictates of market rationality (Chen, 1994). In addition, Chinese management often absorbs ideas from Western and Japanese management wisdom and philosophies. This absorption has been particularly evident since 1979 when China officially opened its doors to the outside world. As a result of economic reform and opening up, many economic sectors have been privatized, and the majority of state-owned enterprises has been decentralized. This consequence has led Chinese firms to have greater autonomy in operation and management decisions. Under these circumstances, these firms are likely to be more dependent upon market forces in judging conditions for decision-making and rely on arms-length principles in appraising transactions. Moreover, the unabated opening up of the Chinese economy in recent years, especially the establishment of thousands of foreigninvested ventures, has encouraged the mixture or convergence of Chinese management philosophy and “modern” Western management wisdom. In fact, learning Western organizational and managerial skills is among the major strategic objectives for both the Chinese government and domestic firms in utilizing foreign direct investment (FDI) (Luo, 1995). This line of reasoning may lead to an argument that the systematic effect of guanxi on a firm’s accounting return and market growth will weaken with time. To test whether or not the above three propositions hold true, we empirically examined the above relationships based on the secondary data (204 firms, 1990–1991 period) collected from Jiangsu province (see Luo and Chen, 1996). In order to examine the evolving role of guanxi in the performance of Chinese firms, we used 1983–1984 as the base period time frame upon which the dynamic impact of guanxi on performance can be explored by comparing it with the current period 1990–1991. This comparison contained 48 firms. The following results were found:

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First, the intensity of sales force marketing has a significant impact on overall performance. This intensity significantly and favorably impacts firm profitability, market growth, and asset efficiency. From one perspective, this evidence empirically confirms the role of guanxi in bringing together millions of Chinese businesses into a web that can be particularly useful for market access and growth. Moreover, although many business dealings are based on clan affiliations rather than arms-length principles, the present study suggests that guanxi is of critical importance to accounting performance, such as profitability and asset efficiency. Second, the intensity of accounts payable is important for the overall performance of Chinese firms and has a significantly positive influence on asset turnover. The intensity of accounts receivable is also crucial to firm success in expanding the local market. These findings indicate that, in the course of business transactions or commercial dealings underscored by guanxi, while the buyer benefits from the economies of accounts payable owed to the seller, the seller gains from the growth in sales. This evidence thus confirms the reciprocity rule of guanxi. Contrary to the third proposition, we did not find that the pattern and magnitude of the relationship between guanxi and firm performance changes substantially over time. The data from two different time frames both revealed the significant effect of sales force marketing and the moderate effect of accounts payable on the overall performance of firms. It demonstrates that, although the opening up and continuous transformation of the Chinese economy are likely to have certain impacts on the conventional wisdom about guanxi and its function in business activities and social behavior, the primary role and principles of guanxi still hold true in this new economic stage.

5.3 MANAGERIAL IMPLICATIONS As the years progress, China will emerge as an economic giant. The World Bank expects that it will become the world’s largest economy early next century if it maintains its recent rate of growth. This is largely due to pragmatic economic reforms and its unabated opening to the outside world. In the course of this economic development, firms in China, both local and foreign, are re-engineering and restructuring the organization in

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an effort to pursue realistic strategies and accommodate firms’ strengths and weaknesses in an environment where industry and market structures are being drastically transformed and government policies frequently change. When firms in China find it imperative to adapt themselves to local settings and competition, Chinese business and management scholars have observed the necessity to narrow the gap between business studies and business practices. This study was therefore designed to fill certain gaps in the field by assessing the performance implications of guanxi, one of the most significant business determinants in Chinese society. Indeed it has long been recognized that doing business in China is particularly difficult and that a key difference between Chinese and Western business practices lies in the relative importance of guanxi in the former, as opposed to the specification and enforcement of contracts in the latter. Guanxi-based business variables have a profound and favorable impact on the accounting and market performance of Chinese firms. In other words, a high performance is a positive function of good guanxi. The Chinese build the relationship and, if successful, transactions and profits will follow whereas Westerners believe that one should build transactions and, if they are successful, a relationship will follow. This difference underlies many of the failures of foreign venture formation and operation in China. Thus, we see Chinese and Western business people approaching new relationships from opposite sides. To a Westerner, it seems straightforward to start with a standard contract, alter it to fit different circumstances and then sign the revised version. Commercial law is ingrained in our thinking. Traditionally in China, commercial law barely existed and its use indicated bad faith. Business clauses might form a useful agenda but obligations came from relationships. Judging from this perspective, it should not seem strange when McDonald’s was evicted from a central Beijing building after two years, despite having a 20-year contract, simply because the newcomer from Hong Kong had strong guanxi with the government whereas McDonald’s had not kept its own in good repair. This study also observes that the high impact of guanxi on firm performance is unabated over time. In China’s new, fast-paced business environment, guanxi retains its preeminent position. It is clear that the Chinese market cannot be tackled effectively today without paying due attention to the construction and

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maintenance of good guanxi. Business transactions with Chinese individuals and organizations need to be approached in the knowledge that the Chinese will place them in the context of their own guanxi networks, which may require meeting obligations to individuals who have no direct involvement in the matter on hand. In China’s collectivist culture, the “real” decision-maker may be the network as a whole, not some mysterious and unseen individual. It is suggested that Western investors and marketers need to establish guanxi of their own, which requires looking beyond the transaction at hand to its implications for the development of personal relationships. In general, a businessperson can demonstrate the good faith that forms the basis for a gradual transition from outsider to insider by bestowing favor and “face” through considerate and sensitive giving of minor gifts, hosting appropriate dinners, and more importantly, giving personal attention. It is also an imperative for Chinese domestic firms to make a good coupling between the conventional wisdom of guanxi and the modern management philosophies introduced from the West. Although these two groups of management philosophies often interplay and interact as a result of the growing integration of global business, this Chapter suggests that the effect of Chinese conventional wisdom is unabated as far as guanxi is concerned. As a lesson for firms operating in Chinese society, an understanding of guanxi’s crucial role in affecting all the major dimensions of firm performance, and knowing the ways of creating and maintaining guanxi networks, are quite necessary for corporate success. Foreign investors can gain an edge over their competitors by understanding and incorporating the guanxi factor into their business decisions.

5.4. GUANXI BETWEEN ORGANIZATIONS Managing interfirm exchange relationships can be quite challenging due to that business relations are embedded in the intricacies of China’s social environments. As part of the deep-seated idiosyncratic Chinese culture, guanxi is an ingrained institution originating from Confucianism — a social philosophy that has influenced the Chinese belief systems for more than 5000 years. Confucianism holds that human beings are relationship-oriented,

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and that building a strong and orderly hierarchy of ties helps achieve social and economic order. To maintain a harmonious and orderly society, guanxi is cultivated through the exchange of gifts and favors between individuals — a social process necessary for creating obligation and indebtedness in order to sustain the accrued ties. For centuries, guanxi have permeated every corner of the Chinese business world. The majority of guanxi studies have followed research of Luo and his colleagues (Luo, 2001; Park and Luo, 2001; Peng and Luo, 2000) who define guanxi as managerial ties between firm executives. As such, these studies commonly delimit top managers as the only domain of guanxi. Still, boundary spanners include not only top executives but also lower-level personnel. Particularly in interfirm exchange, lower-level boundary spanners such as purchasing and sales personnel interact and play important roles in transactions, affecting firm and channel performance. Despite the fact that personal ties are dyadic in nature, prior studies have unanimously examined guanxi from a single-firm view. Guanxi in interfirm exchange from a dyadic perspective is necessary because this approach is in line with the bilateral nature of interfirm relations. Indeed, many interfirm exchanges require close partnerships, thus achieving dyadic performance from the relationship is highly desirable because a relationship is usually more stable and profitable when both parties perform well, or in the alternative, the underperforming party may commit less to or even terminate the relationship. Interfirm exchange provides an important frame of reference for identifying personal ties in social and economic exchange. Due to their boundary-spanning roles in interfirm exchange, ties between firm boundary spanners represent the focal interpersonal ties. Boundary spanners are personnel who contractually represent their respective firms in order to achieve specific goals in interfirm exchange. In a buyer–supplier setting for instance, boundary spanners who are directly involved in channel activities include senior managers at top levels, as well as salespeople and purchasing agents at lower levels. Since boundary spanners (particularly lower-level boundary spanners) routinely interact with each other and connect two firms in exchange, they are more likely to develop personal ties through business interactions.

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Built upon Granovetter’s (1985) social embeddedness argument that economic actions are embedded in social relations, and that the analysis of ties and networks provides a necessary and fruitful vehicle for understanding economic actions, social capital theory recognizes the importance of ties between individuals. As well, social capital theory proposes that social capital accumulated from personal ties generates advantageous outcomes, because ties are conduits providing privileged access to preferential opportunities. Social capital engendered by the fabric of personal ties can be mobilized to facilitate actions. For boundary spanners performing their roles in interfirm exchange, guanxi between boundary spanners affects decisions on sharing and allocating firm resources so that guanxi, thereby, influences the dyadic performance of the partnership. Boundary spanners perform two functions — transmitting information and external representation. In interfirm exchange, these two functions determine communication between the two firms, and affect decisions made by the boundary spanners. Communication between boundary spanners in transmitting market and industry information directly affects information exchange and sharing between partners. Interfirm exchange always involves information exchange, but the quantity and quality of information provided to each party vary greatly in terms of frequency (i.e., the amount of information and whether it is on time), direction (i.e., uni- or bi-directional), modality (e.g., face-to-face, written, telephone, or other modes), and content (e.g., strategic information). Yet firms rely on their partners to provide on-time and high-quality strategic information in order to remain competitive and to achieve performance. Thus, guanxi formed between boundary spanners helps facilitate information transmission and sharing. Through frequent visits, gift exchanges, and social gatherings, guanxi becomes strong ties, expediting business communication and information processing for the boundary spanners which, in turn, benefits the firms they belong to. Based on the norm of reciprocity, boundary spanners with close guanxi are more likely to share market intelligence and experiences to return renqing. Despite the common concern regarding the imperfect information market in China, intelligence passed through boundary spanners who have close guanxi tends to be far more trustworthy, rich, and useful (Luo, 2000). Information and knowledge sharing between partners enables them to collectively (1) reduce

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transaction cost, (2) increase operational efficiency, (3) enhance problemsolving capability, (4) be more responsive to market and industry changes and, thus, improve both parties’ performance. As representatives of firms, boundary spanners also play an important role in obtaining resources and in making important decisions for their respective firms. An underlying assumption is that few firms are internally self-sufficient with respect to critical resources. As a result, resource scarcity introduces uncertainty into a firm’s decision-making. Close ties between boundary spanners, however, can help pool resources between firms, thus increasing firm interdependence and collaboration. Further, the norm of reciprocity gives boundary spanners and their firms the confidence to further engage in the relationship, because boundary spanners know that their counterparts would keep xinyong (credibility) in order not to lose mianzi (face) (Hwang, 1987). Thus, decisions are made with less uncertainty, and operational efficiency contributes to the growth of both firms. Consequently, guanxi between boundary spanners can facilitate interfirm exchange by opening dialogues, acquiring intelligence, accessing resources, and facilitating exchanges of obligations for the improvement of both parties. To make the above work, relationship norms in interfirm exchanges matter. Relationship norms refer to explicit standards (i.e., policies) and implicit standards (i.e., norms) that exchange partners set for expected behaviors during interactions. These standards or norms rely on informal tools such as peer pressure and social sanctions to promote mutual understanding and cooperation. Relational norms reflect expectations regarding attitudes and behaviors that exchange partners have maintained while in working together to achieve mutual goals and to safeguard the continuity of exchange. In interfirm exchange, relational norms are often manifested in the expectations that partners will openly exchange intelligence, widely share ideas and initiatives, be flexible when faced with unforeseen situations, resolve conflicts and problems through consultation and mutual understanding, and actively participate in joint decision-making. Relational norms increase the quality of communication through increased information flows and bidirectional feedbacks. Moreover, because norms implicitly specify permissible limits on behavior, relational norms can provide general standards that not only guide appropriate behavior, but that also prevent deviant behavior. Accordingly,

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through mutual expectations and focused attention on shared values and mutual goals, relational norms can further strengthen the positive impact of guanxi between boundary spanners on dyadic performance. Likewise, relationship attachment between the two organizations matters as well. Relationship attachment refers to social and economic links that bond exchange partners in an existing partnership. In interfirm exchange, interorganizational solidarity represents a social link, while relationship-specific investment signifies an economic link. Solidarity holds partners together in interfirm exchange by shifting their focus away from self-centered behaviors, and toward behaviors that fosters unity. A high level of interorganizational solidarity enables exchange partners to develop mutual understanding and trust while achieving common goals. Such mutual understanding and trust provide boundary personnel with greater confidence and with heightened motivation for effective communication and resource sharing, thereby creating a win–win situation for both parties. interorganizational solidarity also encourages exchange partners to “watch each other’s back,” and to solve their conflicts and problems through joint discussions and consultations, thus prompting boundary spanners to reciprocate the assistance and commitment. The above attachment, often involving so called relationship-specific investment, serves as a bilateral bonding effect. When both parties are committed to such attachment or investment, boundary spanners are cognizant that their firms are willing to “tie hands” and commit to the partnership. When boundary spanners hold expectations that their firms’ partnership will endure for an extensive period, this “shadow of the future” can curb any negative behaviors and motivate positive behaviors in the present.

5.5 PRACTICAL EXAMPLES Minicase 1: Selling in China China’s economy is exploding. Experts estimate the volume of US–China trade at more than US$35 billion annually. US businesses are clamoring to sell even more in the world’s largest emerging market.

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But enthusiastic American companies should avoid taking an overly aggressive attitude toward Chinese customers and joint venture partners. If you want to sell successfully in China, you’d better be patient — and master guanxi, what the Chinese consider the “personal relationship.” While US businesses have been talking about customer relationships for years, in China, this relationship goes beyond taking your prospect out for a fancy dinner or a few drinks. For example, in China getting to know the businessperson’s family will personalize, as well as strengthen, the relationship. Jay Rothstein, President of China Venture Advisors, a San Franciscobased firm that specializes in the facilitation of Sino–American joint ventures, says many US companies attempting to establish joint ventures in China overlook the importance of the personal relationship, and send their top performers to wow the Chinese. “Companies that send their salespersonof-the-year will come back empty-handed,” Rothstein says. “In China, you must become friends before you do business.” Lauren Hsu, Asia business development manager of Frost & Sullivan, an international marketing, research, and consulting firm in Mountain View, California, says cultural sensitivity is essential to mastering the Chinese relationship. In her former position, market analyst for Kohler Company, Hsu was responsible for researching the Chinese market and identifying joint venture partners for the Kohler, Wisconsin-based manufacturer of plumbing fixtures. Once Kohler established a potential partner, Hsu participated in negotiations as both a translator and market expert. Throughout the process, her biggest challenge was convincing the company’s salespeople to adapt to a business culture that is foreign in the US. For example, how many US salespeople need to spend some quality time with their customer’s family before they can close a sale? Sure it’s a nice touch, but definitely not a deal-clincher. But, in the midst of negotiations for Kohler Company, Hsu was invited to go bowling with the partner’s daughter and to a piano concert with the entire family, an experience that pushed the deal into the next stage. Another factor that makes the Chinese negotiation process considerably slower is the number of people involved in the deal. While Americans are generally able to make a decision on their own, the Chinese are intradependent

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and tend to operate on a collaborative basis. Furthermore, it may be difficult to identify the executive who will move the deal forward. “The right person may not be the decision-maker,” Hsu says. “The right person may be the person who influences the decision-maker.” Clyde Swoger, a Kohler international project manager, says language barriers also can be a deterrent in Chinese negotiations. For example, if a Chinese businessperson says “no,” it doesn’t necessarily mean no. It probably means that he needs more time to make a decision. But any deal is possible with patience — and time. The joint venture that Hsu oversaw involved two years of meetings and getting-to-know-you visits. Says Swoger, “Our biggest mistake was having expectations that we would get this done more quickly than we did.” In order to bridge the culture gap, the following advice is offered: (1) never talk business on the first meeting — it’s disrespectful; (2) spend some time with the partner’s family, visit their homes; (3) be aware of language gaps (e.g., no may not mean no); and (4) do not underestimate the time commitment. Source: Adapted from Marchetti (1997).

Minicase 2: Charoen Pokphand in China Charoen Pokphand certainly knows how to get the ball rolling in China. When the group wanted to build a pedestrian overpass connecting its massive retail project in Pudong with a nearby ferry terminal, it went right to the top: CP Group Chairman Dhanin Chearavanont sat down with Shanghai Mayor Xu Kuangdi and explained the walkway’s benefits. Presto, Xu endorsed the 150-meter overpass, says Ming Fei, deputy general-manager of CP’s new joint venture with American real-estate services company Koll. The project was suddenly on Shanghai’s bureaucratic fast-track — and on the way to becoming a small part of CP’s China empire, which stretches from chicken farms and feedmills to motorcycles, telecommunications, and real estate. It’s just another example of how Dhanin gets it done in China. Rich in guanxi, history and investment, CP has proved it can navigate the country’s treacherous business waters. That expertise is the key to attracting strategic

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partners like Koll that have industry know-how, which helps CP reach new markets. For a company like Koll, with no China experience, piggybacking on an established partner like CP is a great way to travel. Many foreign service companies spend months in China searching for a project. Koll had one right off the bat: managing the development and operation of Chia Tai Riverfest, the 240 000-square-metre, nine-story shopping mall CP plans to open in Pudong in 1999. “People would cut off their right arm to get that kind of business,” says T.B. Seow, the Shanghai-based deputy general-manager of Hang Lung Properties, a Hong Kong-based developer with projects in Shanghai. The project arose from Dhanin’s desire to develop and run a worldclass shopping mall in China. CP at first tried to manage the US$300 million project alone, only to deem the task too daunting. “So many things were involved,” explains CP executive Fei, a stocky six-footer originally from Taiwan. “We needed a professional to help.” In 1995, CP asked Neil Bush, the son of former United States President George Bush, to introduce suitable American firms for the project. Californiabased Koll fit the bill: The firm provides a wide range of services, from construction to retail to property management. For its part, Koll recognized a golden opportunity. CP offered a project, knowledge of the local market, a wide array of contacts, and plenty of potential real-estate business down the line. Property development is far from CP’s core concern in China, but it’s not chicken feed either: the group has six big projects totaling more than US$1 billion in investment, and a number of smaller ones. Koll was so gung-ho that it assigned the job of managing its alliance in China to David Mudgett, a senior executive who previously ran its retail operations in the United States. Company officials profess their satisfaction with CP. “As tough as it is over here, if you don’t have a partnership that is supportive, then you have a problem,” Mudgett says. “And we have that partnership.” Still, the combination has brought out some differences in approach. Mudgett ran into a roadblock, for instance, when he recommended that all storefronts in the mall have the same design tone. Although that practice is

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widely followed in America, Fei worries that Chinese shoppers could feel out of place in such an upscale environment. He also frets about the US$10 million CP would have to fork out to ensure a unified look. The partners are still discussing the issue. Says Mudgett, who had never set foot in Asia until 22 months ago, “Koll’s learning curve is a steep one.” Koll also has to get used to doing things the CP way, which sometimes means paying close attention to feng shui , or Chinese geomancy. Mudgett recalls construction on one section of the mall kicking off at 3:45 a.m. — to protect its harmony with the elements. “Feng shui is a totally alien concept to Koll, but it plays a real part in their thinking,” he says as he points to CP’s 1997 date book, which contains red and black dots connoting each day’s good or bad portents. Of course, the venture’s biggest challenge is still well ahead: making the mega-mall turn a profit when it opens three years from now. Customer traffic in Pudong is still relatively low. One reason is that the area’s population of 1.7 million doesn’t yet have the spending power to support a mall this big. Another is that Shanghai residents in Puxi, on the other side of the Huangpu River, still sniff disdainfully at the notion of crossing the water to shop. Subway lines, ferries, tunnels, and bridges connecting Pudong to Puxi will help. But three new foreign-invested shopping malls in Puxi won’t. Nor will the scores of department stores already operating in Shanghai. Yaohan Group’s 108 000-square-metre department store — which opened in Pudong in 1996 — has had sluggish sales so far. Source: Adapted from Yaksko, P. 1997. Model partner. For Eastern Economic Review, 160(4): 45.

Minicase 3: Panda Diplomacy in Action Pandas: Cute, popular and expensive. So expensive, in fact, that the Malaysian government has reportedly considered handing its two adult pandas back to China, the country from which all pandas originate. As part of an agreement made in 2014 by its then prime minister, Najib Razak, Malaysia must pay China $1 million each year to rent the bears until 2024. The new Malaysian

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government, which took power in May 2018, has been reviewing the deal, and this month the leader, Mahathir Mohamad, had to refute ministerial claims that the pandas would be returned early. Why does Malaysia have to pay so much? China has offered pandas as gifts since the seventh century, when Empress Wu sent two bears to Japan. The tradition resurfaced under Mao Zedong. Russia and North Korea were given pandas during the cold war, and America got a pair after President Nixon’s China trip in 1972. By giving its national animal to a foreign power, China is able to emphasize the closeness of political ties. But as China has grown increasingly capitalist, pandas have become an economic tool as well. Instead of giving them away, in the 1980s China started loaning them for $50 000 per month, with the bears and any offspring remaining Chinese property. But the bears were not offered to just any country. Kathleen Buckingham and Paul Jepson of Oxford University found recent panda loans coincided with trade deals that China had signed in Scotland, Canada, and France. They argue that pandas form a key part of guanxi–reciprocal relationships that can establish deeper and more trusting bonds between countries. The animals’ diplomatic importance has led to some controversy. In 2010, a pair of American-born panda cubs were returned to China just two days after China had expressed anger at Barack Obama’s meeting with the Dalai Lama. The National Zoo in Washington had asked for an extension of the loan deal for one cub, but China refused and both cubs were brought back. The timing was interpreted by some as an act of punishment. Panda issues have also clouded China’s relationship with Taiwan: China’s offer of two bears in 2005 was declined by Taiwan’s then pro-independence government, which objected to their names (a play on the Chinese word for “united”). A later sinophile government accepted the bears as part of a strategy of strengthening ties across the Taiwan Strait. Some take issue with the very idea of loaning pandas. When two pandas were brought to Edinburgh Zoo a few years ago, Ross Minett, the campaign director of a local animal-welfare charity, said the bears were “being exploited as diplomatic pawns in a commercial deal”. The zoo itself may not have objected: its visitor numbers increased by 4 million in the

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two years after the bears’ arrival. Thanks in part to pressure from the World Wildlife Fund, China is meant to spend the panda rents on conservation. Whether it does so is not clear, but the number of research and conservation bases has quadrupled in the past 40 years. Increasing the size of the wild panda population is proving a rather tougher task, though. There were 1100 bears in 1976; now there are 1864. Source: Adapted from The Economist (2019).

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6 FOREIGN BUSINESSES AND GUANXI

Foreign businesses can gain an edge over their competitors in the Chinese market by building and maintaining their own legitimate and healthy guanxi network in a country where guanxi can be an effective marketing tool. This chapter first introduces the investment and operational traits of foreign direct investment (FDI) in China. This is followed by a discussion of how guanxi is important to foreign businesses and how foreign business attributes may affect guanxi cultivation. This chapter offers some managerial lessons to foreign companies. Finally, several practical examples are provided.

6.1 FOREIGN BUSINESSES IN CHINA As the world’s largest foreign direct investment (FDI) recipient, overtaking the United States since 2003, China is a shifting and complex territory to foreign investors, and an endless learning journey to practitioners and academics. In the past, for instance, China was seen as a low-competition market full of preemptive opportunities for foreign businesses, and a lowcost land wherein foreign companies gained abnormal returns from cheaper resources, supplies, and labor. Today, China is an extremely competitive market for most deregulated sectors and for consumer products, where foreign businesses fiercely compete against other foreign businesses and local companies that are generally leaner, more flexible, more cost effective, and faster in product development. China used to have a wealth of cheap labor, but the country is now experiencing a shortage in some workforce components, including low-income young workers, an outcome mainly

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caused by the government’s “one-child” policy mandated since the late 1970s. Chinese companies used to be the main suppliers for many foreign businesses, but today many Chinese companies (e.g., TCL) vastly outsource components and parts to Western companies. The selection, compensation, and training of foreign expatriates in China used to be a critical issue in global human resource management, but today some foreign businesses, like P&G, are actually net exporters of local management talent, meaning they have been dispatching more Chinese abroad than bringing foreign expatriates to China. These are just a few examples highlighting China’s shifting environments and foreign businesses’ shifting strategies. Although there was no definite starting point, it was not until the late 1990s that most veteran foreign businesses in China began to move toward a new generation during which they had to cope with drastic changes in market conditions and regulatory treatments, and had to undertake fundamental changes in business strategies and operational policies. Thus, “new generation” foreign businesses do not refer to new or late entrants to China, but rather veteran foreign businesses which have been in China for at least 15 years and presently conduct multiple businesses in multiple locations in an extremely large scale that are coordinated through their China centers. In sum, they shift from early generation (the “foreign investors” status) to new generation (the “strategic insiders” status). The new generation has arisen due to two main reasons. First, both competitive and regulatory landscapes have been dramatically reshaped since the late 1990s, along with substantial changes in the demographic, economic, political, and socio-cultural segments. Foreign businesses had to fundamentally redefine their strategies to cope with these changes and to secure the critical market share they had established. Second, after early stage operations in China, most foreign businesses had to redefine their strategies and structure to meet internal needs. These firms raised their strategic sights and expectations from operations in China, consolidated a large array of independent units in different locations of China into an umbrella system, searched for financial and operational synergies by coordinating and supporting different business units in various common

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functions, and engaged in both upstream and downstream diversifications to fulfill increasingly localized value chain integration.

Shifting Environmental Conditions Given China’s sheer consumer size, phenomenal economic growth, and increased market openness, winning in China has unsurprisingly become a top priority for many foreign businesses that see the market as a prime opportunity to catapult themselves into positions of global leadership. In 2003, China’s GDP reached US$1.4 trillion and per capita GDP passed the US$1000 mark for the first time, a sign of improving living standards and consumer market. The country, however, is always an extremely complex market full of challenges and constant change. Examples of these changes include: (1) China’s advantage used to lie in low-cost labor, but today strong domestic players emerge based on fast product development; (2) China used to be perceived as one economic world, but now it has first (e.g., Shanghai and Beijing), second (e.g., capital cities), and third worlds (e.g., interior rural areas) all combined; (3) China used to be a state-run economy, but today two-thirds of the economy is comprised of domestic private businesses and foreign-invested enterprises; (4) China used to rely on foreign capital and government investment to sustain its economic growth, but now 80 percent of China’s investment comes from Chinese people, driven by 40 percent saving rates and 40 percent investment rates; (5) China used to be a shortage economy, but today it creates overcapacity of production in many industries, caused by a combination of explosive fixed investments (30–50 percent growth annually) and overlending by state-owned banks; (6) China was often cited as the world’s largest market, but private consumption accounted for only 45.1 percent of GDP in 2002 (70.5 percent in the US) with household savings rising almost 20 percent annually, signaling consumers’ need for saving for healthcare, education, housing, pensions, and other services no longer provided by the government; and (7) many foreign businesses used to lose money in China, but today two-thirds of them are profitable, with about US$7 billion in dividends repatriated from China (including Hong Kong) to US parent firms in 2002.

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New Competitive Landscape China’s competitive environment has been fundamentally changed, mainly by increasing purchasing power of middle-class consumers, aggressive expansion of domestic enterprises and foreign companies, escalated openness of inland markets, and continuous but uneven deregulation of economic structure.

Shift from scant competition to strong competition For most early generation foreign businesses, the main challenge was to negotiate joint ventures and establish local manufacturing facilities. Competition was weak, and if it existed, arose scantly from other foreign businesses (e.g., rivalry between Coca-Cola and PepsiCo or between P&G and Unilever). For these foreign businesses, it was generally sufficient to focus on higher-end distribution or retailing outlets. Recently, competition has intensified dramatically, making market share and volume growth extremely crucial to the survival of new generation foreign businesses, especially those in mass-market categories. In skin care, food, and premium beer, for example, more than 60 world-class competitors now have manufacturing facilities in China, more than five times as many as there were in 1990. In addition, many mid-sized Asian manufacturers from Singapore, South Korea, Taiwan, Thailand, and Malaysia have used their superior understanding of China to make significant inroads, further fortifying competition among foreign investors themselves. The biggest new competitive threat, however, comes from aggressive and powerful local enterprises. In the desktop PC sector, Legend, a local company, is now the leading player with 30 percent market share, and two other local companies are in the second and third positions with a combined 14 percent of the market. A recent survey (see Williamson and Zeng, 2004) suggests that foreign businesses generally start off with clear advantages in superior technological capabilities (technology, know-how, and innovation) and managerial capabilities (branding, finance, IT, and value chain integration). However, foreign businesses face several critical handicaps in the battle against local competitors; including (1) poor supporting infrastructure that

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prevents them from exploiting their advantages; (2) fragmented distribution channels and underdeveloped logistics systems that hamper their efforts to reach potential customers; (3) inadequate flexibility and higher costs imposed by the need to integrate China operations with a global chain; and (4) protected trade barriers across provinces that deter foreign businesses’ ability to reap economies of scale and spread high fixed costs. Chinese competitors possess unique advantages that make them much less hindered by the above handicaps. Chinese competitors are leaner, more flexible, and have lower costs and a better understanding of the local environment. Many local companies are run by highly entrepreneurial people who have either grown their businesses from the seed of flexible township or village enterprises, transformed state-owned enterprises into joint-stock companies with strong managerial autonomy, or launched new private investments that are flexible and cost-effective. Local competitors are more competent in the subtle art of cultivating and managing the complex web of relationships that are necessary for firm growth in China. Although healthy, stable, and quality relationships alone are not sufficient to win market share, they are value-added social capital that may reduce transaction costs and operation uncertainty or enhance institutional support and business expansion. Despite the general inferiority of local companies in original technology and innovation, the existence of open global markets in applied technology, advanced machinery and equipments, the latest tools and instruments, and sophisticated materials and components allow local copycats to simply buy much of the technology and expertise they need. In the PC market, for instance, the latest tools and technologies developed in Silicon Valley now arrive in China within months. This, for instance, allows Dongguan, a small city in the Guangdong province with the world’s highest concentration of component manufacturers, to provide Chinese PC makers with a ready supply of world-class technology.

Shift from niche competition to massive competition Most early generation foreign businesses used to target primarily the highend niche market in search of high premium. In the early years after the

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Chinese market was opened in late 1978, the active consumer market that could afford international brands was small; this group was defined as the high-end segment in Prahalad and Lieberthal’s pyramid structure of emerging market consumers. Accordingly, competition facing early generation foreign businesses essentially took place among foreign companies that originated from the US, Europe, and Japan and in niche segments — high-end consumers in major metropolitan areas. Today, new generation foreign businesses are seeking to tap into the mid-end segment, and some are even looking for the low-end segment active consumers. This shift has resulted in massive competition where the ultimate winners are often those equipped with a superior ability to serve the mass market, especially the mid-end segment, cost-effectively (many local competitors have an important advantage in cost effectiveness). The mid-end market composes a much larger group of active consumers who mostly fall within the middle class. In China today, there are approximately 70 million middle-class consumers, most of whom live in 170 cities that each have populations exceeding one million. Of this group, about 18 million have incomes of more than US$24 000 a year. These consumers are getting a fast education in global standards, but they are often unwilling to pay global prices. Thus, they are far more sensitive than their Western counterparts to the price/quality or price/performance ratio. This sensitivity tends to give low-cost local competitors the edge in fiercely contested markets, but foreign businesses can turn it to their advantage by sharpening brand image and maintaining superior quality. It is not surprising to see that brand-driven massive competition is intensifying — foreign and joint venture brands, local copycats, and increasingly enticing domestic brands, both national and regional, all crowd the market. Building a competitive advantage in massive competition is no longer solely about the product, but instead requires the maintenance of significant innovation, quality, and brand advantages. In this environment, new generation foreign businesses must vigilantly watch for up-and-coming local brands and for counterfeit products that dilute brand equity. Additionally, gaining a sizable share in massive competition necessitates volume share. For example, 70 percent of P&G’s profit comes from its mid-and low-end segments. If the company had not constantly committed to

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volume share in high- and mid-end segments, it would not have succeeded in upholding a sustainable leading position because it would otherwise leave too much room for lower-cost producers to undercut its pricing and capture its market share. After all, a shift from niche competition to massive competition is among the most daunting challenges to new generation foreign businesses because they must reduce costs, enhance economies of scale, maintain quality, and improve adaptation, all without cannibalizing their high-end, high-priced products.

Shift from single-market conception to multi-market competition The Chinese market is actually a conglomeration of markets segmented by such factors as levels of economic development, industrial priorities, local cultures, and more importantly, purchasing power, consumer behaviors, and distribution channels (see Cui and Liu, 2000). These differences divide the Chinese market into five tiers: (1) tier 1 includes Beijing, Shanghai, Guangzhou, and Shengzhen; (2) tier 2 consists of provincial capitals along east and south coast; (3) tier 3 comprises non-capital cities in east and south coast provinces and capital cities in inland, western, and northern provinces; (4) tier 4 contains non-capital cities in inland, western, and northern provinces; and (5) tier 5 is rural area including counties, towns, and villages. Early generation foreign businesses mostly focused on the first two tiers and viewed them as representative of the Chinese market, thus generating a misconception of China as a single homogeneous market. New generation foreign businesses realize that tiers 3–5 are the faster-growing segments with more opportunities than the first two tiers, but significantly different from the first two tiers and from each other in terms of purchasing power, attitudes, lifestyles, media use, and consumption patterns. Specifically, tiers 1 and 2 are developed growth markets in which new generation foreign businesses are heavily competing in markets where product life cycles fall between growth and maturity. The growth potential in these two tiers has certainly not been fully exhausted because of heightened purchasing power of high-end and mid-end consumers, however, this potential depends

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on a foreign business’s industry or product category. Tier 3 represents China’s emerging markets for foreign products. Tier 3 areas are less developed or less congested than tiers 1 and 2 but more advanced in economic development and have more affluent consumers than the tiers below them. The largest number of new and financially capable consumers to whom foreign businesses’ massive products are appealing are in this category. Finally, tiers 4 and 5 are largely untapped markets for foreign products, still waiting to be explored by foreign firms. These last two tiers together contain China’s largest population and will become increasingly attractive as their income increases. Strategic insiders have also realized that each tier or region has its unique geographic typography, economic base, investment infrastructure, and cultural heritage. Consumers in various regions are known to differ in income, values, lifestyles, and extent of contact with the outside world. These differences in turn affect consumers’ perception of foreign products and their purchase readiness, and present tremendous invisible obstacles between the tiers, making it difficult for new generation foreign businesses to exercise a nationwide universal marketing and distribution strategy.

Shift from structural similarity to structural multiplicity During the early generation period, foreign businesses were generally subject to similar government restrictions and similar entry barriers in entering different industries. Due to the central government’s new industrial policies that allowed only some sectors to be deregulated, adopted industry-varying consolidation tax rates, and placed different entry barriers to different industries, China’s industry structure has moved toward multiplicity, dissimilarity, and heterogeneity. As a result, both opportunities (e.g., profit and sales and first-mover privileges) and threats (e.g., regulatory constraints and investment infrastructures) vary largely across industries. This is further compounded by the transformative nature of China’s economy and the experimental nature of its new industrial and investment policies. The impact of FDI on China’s industrial structure has been tremendously idiosyncratic across industries as well. The structural influence of FDI on the chemical industry and the raw materials industry is rather limited. The output share of FDI in the oil refining, petroleum chemicals, cement, steel, and

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electric power generation industries is all less than 5 percent of an industry’s total. Instead, FDI tends to dominate “import-substitution” industries, such as elevator and auto-making where foreign companies have early-mover advantages and occupy more than 50 percent market share. Similarly, the structural influence of FDI in light industry, electronics products, machinery, and pharmaceutical industries is enormous, as manifested in vigorous competition between all participants, whether foreign or local. Within the multifaceted and heterogeneous industry structure, new generation foreign businesses face markedly different opportunities and threats depending on the industries. Foreign businesses that sell products that range from elevators to subway systems and automobiles to mobile phones are finding China to be their most important market for growth. In such sectors as consumer electronics, processed foods, and pharmaceuticals, late-arriving foreign businesses may have already missed the boat. In these extremely competitive sectors, increasingly large commitments and reinvestments are needed to shape the industry structure in order to pave a path for sustainable and superior returns. In these sectors, aggressive local competition not only rules out an early-move position but already results in overcapacity and falling prices and profits. For instance, overcapacity in air-conditioners, microwaves, refrigerators, washing machines, and color TVs already reaches from 35 to 150 percent. In other fields, the country is not yet but will soon be a significant market because the repressed demand has not been seen due to regulatory impediments (e.g., media or airline service).

New Regulatory Landscape Continuous economic reform and structural transformation, together with changes in overall regulatory structure, development of legal systems, and WTO membership, institute a series of shifts of governmental policies that impact foreign businesses.

Shift from entrance restriction to operational intervention From the 1980s through the late-1990s, the Chinese government oversaw inbound FDI mainly through entry intervention, that is, emphasizing FDI

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project ratification through which the government authorities could manipulate FDI size, location, timing, and even partner selection. Due to the lack of experience dealing with foreign businesses and the fact that many industries remained regulated, the government was mainly concerned about which industries to open to foreign investors and where FDI should be directed. Most laws, rules, and regulations were associated with ways to control foreign entry and to ratify FDI applications by government agencies, such as the Ministry of Foreign Trade and Economic Cooperation (now the Ministry of Commerce) or their provincial departments. This emphasis was reflected in China’s early regulations, such as the Joint Venture Law. Since the late-1990s, Chinese government policies on FDI began to shift the focus from entry intervention to operational interference. The government has enacted a large body of regulations regarding component localization, geographic coverage, minimum export level, distribution restrictions, local worker unionization, environmental protection, financing criteria, and accounting standards, among others. These measures have strongly influenced foreign businesses’ market orientation, marketing efficiency, human resource management, outsourcing strategy, and financial management. At the same time, many hurdles involving FDI entry have been eliminated. China has been gradually relaxing restrictions on foreign ownership and on establishment of wholly owned subsidiaries. Foreign businesses have been allowed to access and to operate in more industries. Many previously restricted service sectors (e.g., retail, insurance, tourism, hospitals, trading, accounting services, and banking) have been opened up to foreign companies. Restrictions in partner selection, location, and entry mode have also been significantly relaxed. In nonrestricted industries, restrictions in these aspects are essentially gone for FDI projects.

Shift from overt control to covert constraint When governmental policies become more opaque and less open, a shift toward covert constraint occurs. This shift is especially evident in regulated industries (e.g., telecom, automobile, insurance, retailing, Internet, transportation, banking services, and power generation) and in such areas as

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foreign exchange conversion, regulatory standards for building investment or holding companies, outright prohibition of investment in certain industries, and developing distribution networks. In 2000, for instance, the Chinese government published new regulations that require all companies providing Internet content to apply for licenses. Under the new rules, Internet companies that provide news or supply information about education, health care, pharmaceutical products, and medical instruments must be approved by regulatory agencies including the Ministry of Information Industries (MII). In the area of foreign exchange control, the harsh requirements for selfbalancing foreign exchange earnings with foreign exchange expenditures were restrictive but were overt and clear. After liberalizing this regulation in the late 1990s, excessive smuggling and foreign currency leakage prompted the central government to pay closer attention to foreign exchange conversions and flows. Thus, China tightened controls on foreign exchange flows since then, a move aimed largely at preventing Chinese companies from sending foreign currency abroad illegally. This change, however, had unintended effects on legitimate foreign business operations. Similarly, although China did not phase out a tax exemption on imports of capital equipment used by foreign companies, since 1997 it has required foreign companies to meet stringent requirements, including scrupulous tracking of each piece of equipment covered by the tax exemption. These examples show how covert measures allow the government to crack down as called for under-existing rules. These covert measures also mean that policy changes can come swiftly. Covert measures are also employed in other areas. Many regulations contained in the Price Law and the Anti-Trust Law, for instance, are ambiguous, greatly empowering governmental agencies such as the State Administration for Industry and Commerce (SAIC) to explain and interpret rules and policies relating to unfair competition and pricing practice. Regardless of whether the price of a good or service is market- or governmentdetermined, these laws permit the government to take various steps to cope with “emergencies,” which are interpreted only by the SAIC. In addition to curbing unfair competition or unfair pricing practices, these two laws attempt to crack down on businesses that fail to implement government-guided prices, or temporary interference or emergency measures. Similarly, the Advertising Law provides a set of new guidelines in an attempt to weed out

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fraudulent advertising and requires that all advertisements correspond to the “demands of socialism,” a phrase that remains clouded in ambiguity as to its exact meaning. This ambiguity and its derivative interpretation rights give the SAIC opportunities to intervene in foreign companies’ advertising practices. The main reason for the shift to covert measures can be ascribed to the fact that some industries are growing so fast that regulators are having trouble keeping up. Many emerging practices or problems — unfair competition, direct selling, intellectual property right infringement, and environmental protection, for example — also give rise to many new concerns for governmental regulators. On the one hand, the lack of experience in dealing with these emerging problems or experiment-type practices allowed by the government causes many new regulations and laws to be ambiguous. On the other hand, the opaque rules provide various authorities exclusive rights to explain and interpret the ambiguous regulations, which in turn provides them with opportunities to intervene in foreign businesses. It is this interpretation and explanation that makes regulatory policies particularly covert to foreign companies.

Shift from separation from to convergence with domestic policies Most FDI laws and regulations faced by early generation foreign businesses were separated from other laws associated with the nation’s domestic economic, procedural, administrative, and civil laws. The majority of FDI rules were independently documented and not part of related domestic laws. These FDI rules and laws included two categories: central laws, which were all enacted and promulgated by China’s National People’s Congress, the highest legislative body in the country, and a large number of detailed rules, provisions, interpretations, and interim regulations adopted and issued by the ministries under the State Council. Since the late 1990s, foreign business-related rules and regulations are in large part contained in various laws relative to domestic economic, procedural, administrative, and civil legislation. For example, the Labor Law

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describes the rules by which foreign companies should abide in providing welfare benefits to local employees. The Company Law includes an article mandating that foreign companies are bound to the same business ethics and social responsibility requirements as local companies. In the Partnership Business Law, an article specifies that all regulations in the law also apply to foreign businesses. The Price Law states that all businesses, including foreign businesses, are prohibited from fabrication and spreading of rumors of price hikes to force prices to rise and from attaching business through deceptive pricing. The law forbids businesses, including foreign businesses, from colluding in manipulating market prices and jeopardizing the legitimate rights of competitors or consumers. Similarly, the Foreign Trade Law contains specific terms describing import and export rules and procedures that all foreign-invested enterprises must observe. The main reason for this shift is that China’s overall regulatory framework regarding foreign businesses is heading toward equal treatment of foreign and local firms, gradually eliminating discriminations against foreign companies in the area of operational rights as well as removing preferential treatments offered to these companies in the area of taxation, vis-à-vis local counterparts. Combining laws regulating foreign and domestic businesses into a single piece of legislation governing both and treating these businesses in the same manner represents an important step in the direction of equality, and signals positive development of the regulatory framework governing foreign business activities in China.

Shift from regulatory rigidity to regulatory elasticity In the past, the central government dominated the law enactment and enforcement associated with foreign business activities. Under the control of the central government, most policies were rigid, and local authorities or industrial ministries did not have the authority to change these policies. Moreover, foreign business activities were concentrated in coastal regions and in competitive industries, which involved fewer variations in terms of environmental dynamics across regions and industries. Thus, policies on foreign business activities, such as foreign currency remittance, corporate

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income taxation rates, import tariffs, and duration and rate of land lease, were virtually nonnegotiable and were largely consistent nationwide. Since the late 1990s, this situation has changed. Many FDI policies are now changeable and negotiable, depending on a foreign business’s bargaining power and how a foreign business negotiates with the central or local governments. Two main factors affect the elasticity of these policies. First, financial and operational treatments are negotiable with regional authorities. For those foreign investments that are fundamental to economic development in the region (e.g., infrastructure investment, high-tech development, foreign exchange creation, and a large pool of employment), foreign businesses are in a strong position to bargain with regional government authorities for better regulatory stances or treatments, especially in financial areas. Those maintaining a superior cooperative relationship with regional authorities or a stronger bargaining power arising from resource commitment are now likely to have longer taxation breaks or lower rates. The second aspect of elasticity relates to industry access and ownership requirement. In those industries undergoing substantial structural transformation or only partially opened up to foreign businesses, restrictive and bureaucratic rules set by the central government are negotiable, and related ministries in charge become flexible in enforcing and overseeing these rules. The shift from rigidity to elasticity arises for several reasons. First, China faces increasing competitive pressure from other emerging economies in attracting foreign businesses’ investments. To some extent, regulatory flexibility demonstrated by the host government encourages foreign businesses to enter and creates more favorable conditions for foreign businesses’ investments and operations. Second, regulatory elasticity is particularly apparent in industries that have recently deregulated and opened to foreign businesses. In the absence of administrative experience, government policies in these industries are essentially designed on a trial-and-error basis. The regulatory framework in these sectors is still being developed, thus providing foreign businesses with opportunities to make better bargains. Third, the differences in economic development and income levels across provinces have recently increased. Less developed regions require more support from the central government. These regional governments now have special authority allowed by the central government to change some

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national FDI policies, which consequently prompts regulatory elasticity in such regions.

Shifting Dominant Strategies New generation foreign businesses commonly share the following investment and operational features. First, their local operations have already reached an extremely high scale, with China operations accounting for at least 10 percent in corporate sales or capital investment. To maintain or develop this position, they continue to aggressively expand their scale and scope by investing new parent capital in new projects and/or reinvesting accumulated retained earnings in existing projects. For example, Motorola plans to increase investment, revenue, and procurement by US$10 billion each in China over the next five years while GM plans to generate more than US$3 billion of revenue by 2008. Second, new generation foreign businesses have already established a large number of investment projects in numerous locations and performed under various kinds of entry modes, from co-production to equity joint ventures and from sales branches to wholly-owned subsidiaries. Siemens, for instance, has built over 60 large projects across China and employs more than 30 000 Chinese people in its four dozen joint ventures and a dozen whollyowned subsidiaries and branch offices. New generation foreign businesses, like Anheuser-Busch and Heineken, are also proactive in acquiring local companies or participating in local enterprise ownership to better reach untapped regions or segments or to reshape their competitive posture. Third, new generation foreign businesses are evolving into strategic or dominant players, shifting their strategic goals from establishing a local presence and learning about China to securing dominant market share and achieving sustained high returns. They are no longer opportunistic experimenters and have instead become strategic insiders, such that they are portrayed as truly local players by the public, market leaders by consumers, and long-term contributors by the government. Along with these features, new generation foreign businesses are shifting their fundamental strategies in the following areas.

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Shift from parent integration to national integration In the early stage of operations in China, every individual subunit, whether a joint venture, wholly-owned subsidiary or any other form, conducted virtually all its own activities or performed its strategic roles alone, as designated by corporate or regional headquarters. Thus, individual subunits within China did not horizontally interact nor operationally collaborate with one another, often resulting in redundant sales and distribution activities in the same market and duplications in product development, training, recruiting, public relations, and other common functions. Individual subunits seldom worked together in a coordinated fashion, resulting in a lack of a unified corporate face in China. This was even more evident when a foreign business (e.g., Du Pont) used the product divisional structure to govern worldwide operations. As strategic insiders face the challenge of organizing an increasing number of subunits in various forms and locations within China, they become acutely aware of the need to cost-effectively and coherently manage the entire span of activities simultaneously undertaken by many subunits. As a response, many of them have built the China centers as the local headquarters to consolidate common functions and integrate various nationwide subunits. Legally, these centers are investing holding companies (also known as umbrella companies) independently registered in China. Increasingly, China centers perform many functions that used to be done by parent headquarters. A China center fully integrates and combines sales, procurement, subsidiary investment, manufacturing, training, public relations, taxation, and maintenance services for a broad range of products within China. Also, local integration through a China center helps improve the cash flow and capital structure of various investments by acting as a clearing-house for intra- group financing. It can also facilitate the smooth establishment of new investments. National integration is especially important for foreign businesses that are multidivisional, where their China centers coordinate many common functions for individual subunits that belong to different corporate divisions. Centralized national integration through an umbrella company can generate several benefits through synergy-creation functions. Usually, each subunit has to set up its own sales capabilities; an umbrella enterprise can

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achieve greater efficiency by integrating certain marketing activities. Because marketing and distribution channels are rather segmented and regionalized in China, integrated marketing and distribution through the center is more costefficient in reaching consumers nationwide. It also gives foreign businesses greater control over brand management and volume-related market power than it could achieve through individual subunits separately. Second, the umbrella model creates an overlay structure to provide shared or centralized common functions in R&D, market research, sales force management, provision of product maintenance services and technical support, and purchase of production materials. Through centralization of common functions, research, marketing, and purchasing expenses are reduced due to sharing critical facilities, talents, and expertise. Centralizing these common or support activities will avoid cost duplication and, equally important, make effective use of critical resources across individual subunits in the same country. Additionally, the model facilitates cash flow or foreign exchange balance for all local activities. Financing via the China center elevates bargaining power vis-à-vis local banks and lowers loan rates due to aggregated firm size or asset size, as compared to financing via individual subunits. Since the center can net out financial positions in various currencies for transactions conducted by individual subunits, national integration reduces China-wide foreign exchange exposure and hedging costs incurred by individual subunits that would otherwise have to buy or sell forward or option independently. These centers support the payment, treasury management, and accounting operations for multiple subunits. Locating data processing and call functions in these centers is also a trend among foreign businesses. Moreover, the umbrella model consolidates and streamlines new investments and project developments. The China center articulates the corporate vision for China and is responsible for developing the foreign business’s overall China strategy. The center typically reviews all investment proposals from individual subunits and endorses those that complement the overall strategy. Balancing subunit priorities with overall China strategy and corporate priorities in an extremely dynamic environment is at the heart of the China center’s responsibilities. The umbrella’s coordination increases the possibility that a particular subunit pursues an investment that is suboptimal in itself but would also greatly stimulate synergy generation

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with downstream or upstream activities conducted by sister subunits in China. Proactive umbrella centers also assume direct responsibility for identifying, structuring, and capturing opportunities before assigning them to specific subunits. In addition, the China center can consolidate training of both local employees and expatriates and accordingly reduce training costs and improve training quality. Through the centralized training center at umbrella headquarters (e.g., Motorola University in Beijing), each individual subunit no longer needs to set up its own training department or facility, thereby eliminating a large expense for individual subunits. Extra gains may also arise from unified actions and consistent policies in recruitment, retention, motivation, and dismissal. The umbrella model is also effective to help cultivate legitimate and sustained relationships with business community members such as regulators, suppliers, distributors, buyers, and partners. In particular, government relations and negotiation support are fundamental common functions falling under the purview of the umbrella. Because the Chinese government tends to view the activities of individual subunits as part of a single foreign company’s effort, making a uniform country strategy, especially the relationship-building strategy profoundly necessary. Having the China center coordinate the relationships with Chinese authorities at the central and provincial levels ensures a foreign company a consistent message from numerous subunits and fortifies negotiation and bargaining power vis-à-vis government bodies. In fact, many new generation foreign businesses arrange occasional but effective “top-to-top” meetings while cementing relationship-building between lowertier authorities and subunit executives. Additionally, pooling and sharing talented negotiators across subunits is synergetic as well, both because the necessary skills are unique in China and because lessons learned from one series of negotiations with regulators, suppliers, joint venture partners, and the like often prove valuable in the next round. Finally, the umbrella center not only coordinates individual subunits in China but also serves as a unified and centralized hub linking China subunits with subunits in other countries. Because the China centers typically directly report to the corporate-level executives at home, they are in an ideal position to receive corporate plans and feedback local situations to corporate headquarters. The umbrella model essentially curtails the drawbacks of

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global matrix or global divisional structures such that the product–market interface and cross-divisional sharing are strengthened through the umbrella hubs in a priority market. For foreign businesses wherein sharing experience, R&D and best practice among global business units in different business categories and in different countries is pivotal, strong umbrella centers will be even more essential in this respect.

Shift from production relocation to value chain localization Relocating home production facilities to China was the priority for most early generation foreign businesses. For other critical value chain activities such as procurement, R&D, branding, sales, distribution, training, and personnel, foreign businesses either relied on their joint venture partners or on their parent or corporate members in other countries. Although this pattern comported with the evolutionary logic, it became ineffective when early generation foreign businesses transformed into new generation foreign businesses pursuing large-scale operations and sales in the Chinese market. Ineffectiveness arose from the fact that many joint venture partners failed to deliver such value chain contributions and/or that such value chain activities needed to be localized to cope with cost-cutting pressure, quicker turnaround requirements, and unique local demands. New generation foreign businesses are active in establishing the primary activities of the value chain, such as local supply bases, warehouse centers, distribution networks, service centers, and the like. To increase profit margin and input quality, strategic insiders, such as Motorola, P&G, and Gillette, have recently built supply bases within China, most of which are very near their main production facilities. At Ford, about 70 percent of the Fiesta’s parts comes from its Chongqing factory. Early generation foreign businesses had not seriously invested in distribution. Under the former planned economy, most distribution networks were controlled by the government and instituted by state-owned agencies at various hierarchical levels. Even at present there is no real national distribution network for most products. Many foreign businesses had gained access to provincial networks by creating joint ventures, but Chinese joint venture partners protected their turf. This gap between

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foreign businesses’ need for a national cost-effective distribution system and the more locally oriented goals of their partners created serious tensions. As a remedy, strategic insiders are building their own teams to promote, distribute, and merchandize their products in a large number of outlets or are improving distribution control. Typically, those with large volumes, such as Coca-Cola that can afford to bypass local distributors, have substantially reduced their dependence on wholesalers in major markets by selling and trucking their products directly to tens of thousands of retailers. This gives them a distinct edge in controlling product positioning and promotions. Other foreign businesses heighten their control over major wholesalers by assigning their own staff to work directly with these wholesalers, train their sales forces, and install systems for monitoring inventories and performance. Along the supporting activities of the value chain, new generation foreign businesses are significantly localizing their procurement, applied research, product development, training, management, and finance. By establishing a purchasing center or procurement office in China, foreign businesses can eliminate one or more of the agents that stand between them and their original suppliers. In addition to using China as the “world factory” for manufacturing, foreign businesses are setting up R&D centers there to satisfy escalated needs for innovation, adaptation, and differentiation demanded by local consumers. Motorola has invested US$155 million in 18 R&D centers throughout the nation, Lucent Technologies set up two Bell Labs, and Intel recently committed US$50 million to its Intel China Research Center. To improve managerial skills of local talent, many strategic insiders are building company schools in China. Motorola University in Beijing, for instance, helps young managers by offering a variety of training options. One of them, the China Accelerated Management Program, was created as a rapid-entry training effort to develop capable middle managers in the short term and general managers in the long term. Likewise, ABB set up its ABB China Business School to organize courses for the company’s employees working at its two dozen subunits in the country. The conventional wisdom of the value chain system does not include educational investment in either primary or support activities, an issue that is critical to foreign businesses’ profit margin in emerging markets. Educational investment involves a foreign company’s well-planned strategic commitment of resources invested to train or educate a priority country’s customers,

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suppliers, distributors, and partners. Transforming the potential demand in a large emerging market into materialized demand for technologically-intensive new products often necessitates such educational investments by foreign businesses that intend to build a dominant market position there. Compared to early generation, new generation foreign businesses are more active and “strategic” in such investment because they themselves are the primary beneficiary of the investment. To make itself a leading networking solution provider in China, for instance, Cisco views educational investment as a key element of its China strategy. The company regularly holds networkers conferences (2–3 days) in Beijing, where thousands of customers are trained and certified by Cisco. The company has set up 20 branches of its global networking academy program in Chinese universities where its training and certification are also offered. The ultimate goal of value chain localization is, of course, profit margin. While early generation foreign businesses often looked for long-term financial returns, new generation foreign businesses are looking for both long- and short-term results. Early generation foreign businesses often justified their poor short-term performance with the argument that China was a longterm market. Veteran foreign businesses must be able to generate positive short- term results while still moving toward the long-term plan; otherwise their existing strategies or policies may be wrong or outdated at best. For strategic insiders, sustainable long-term positions are necessarily built on a series of successful short-term moves. Short-term results can help build brand recognition, attract local talent, and bolster resource commitment to continuous insider development, all critical to creating a virtuous cycle and upholding a strong position ahead of rivals. If veteran foreign businesses still cannot generate positive short-term returns after operating in China for more than a decade, they are failed investors, not strategic insiders.

Shift from competence transfer to competence building Shifting competitive landscapes have prompted strategic insiders to build new competencies that help complement and exploit their existing capabilities before other players establish a strong lead. For early generation foreign businesses, competence and resource transfer from parent firms to emerging

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market subsidiaries fit in well with the experimental nature of a small local presence and was generally adequate to fulfill the objective of learning about market dynamics and business development. New generation foreign businesses are compelled to build new competencies because the skills they need to master to fortify their competitive advantages in China’s new competitive environment cannot be directly bought. Instead, they have to painstakingly learn, adapt, upgrade, or develop new capabilities. Under the current competitive environment, it is particularly important for strategic insiders to build such competencies as brand, innovation, distribution, human capital, and social capital, among others. In today’s China, brand competition is intensifying. Strategic insiders must not only effectively develop and promote their own brands but also cautiously watch and protect their names due to the widespread problem of counterfeits that dilute real brand value. To make global brands appeal to Chinese consumers, most foreign businesses translate global brands into their Chinese names in a very creative way such that the brands are known in China only by their Chinese names. P&G’s “Pampers,” for instance, means “helping baby’s comfort,” “Whisper” means “protection, comfort and a precious item,” and “Ariel” is about the bright and clear way of cleaning. Such Chinese names trigger meaningful visuals or associations with benefits. Chinese consumers today see many foreign brand names such as Budweiser, Tide, Ariel, Crest, Coco-Cola, and Frito-Lay as Chinese brands (each with more or less 50 percent market share at their peak) from global companies with great reputation. Success in branding competition often occurs in more precisely defined consumer groups through more targeted strategies and execution. Thus, a first step toward branding is not simply understanding what people buy, but which segments of consumers buy what goods and why they buy them. For a company with a category of products seeking diverse reach across multiple tiers in China, it is important to differentiate not only product offering, pricing, and consumer communications to meet specific needs of each segment but also different brand or sub-brand names so that high-priced products are not cannibalized by low-priced ones. Product, process, and managerial innovations are vital to holding a strategic insider’s dominant position. Building competencies through localizing R&D has been common; over 10 dozen R&D centers have been

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established in China by such companies as HP, Microsoft, and Motorola. Such efforts improve proximity and responsiveness to local customers and increase speed to market. Given China’s vast supply of cheap and talented scientists and engineers, localizing R&D also reduces development costs. In addition, setting up research or development facilities signals commitment to the local economy. Therefore, it helps relationship building with governments at various levels and increases bargaining power for soliciting official support for other parts of a foreign company’s Chinese business. To mitigate the leakage of intellectual property rights (IPR) associated with local R&D, strategic insiders do not merely use defensive approaches such as walling-off clauses, secret coding, and cross-licensing, but they also adopt a more active, offensive measure — continually investing and developing new technologies so that local imitators always lag behind. Additionally, managerial innovation — the extent to which senior country managers have the forward-thinking philosophy, sharpened mindset, and savvy leadership to cope with environmental changes and seize emerging opportunities — is an essential competence in a constantly turbulent market like China’s. To build it, many strategic insiders have formed a top management team in which each member (senior executives at the umbrella center and at individual subunits) must have had at least five years of leadership experience in China or the Greater China region before being appointed. Similarly, new generation foreign businesses have noticeably localized their management teams, aggressively recruiting top talents in the industry, and heavily investing in training to develop human capital, a key competence in the country largely governed not by law but by people. To further develop local talents’ global experience, management skills, and industrial experience, many foreign businesses have extensively rotated local talent through various countries and positions within the corporate network. It is not surprising, therefore, to see that there are more Chinese working overseas than expatriates working in China at some foreign businesses like P&G and J&J. This rotation and related possibility of promotion is also an effective way of retaining human capital developed by the company (turnover in China is 30–40 percent, which causes serious problems such as leakages of IPR, trade secrets, and management intelligence). Meanwhile, expatriates become more, not less, important to strategic insiders, especially in helping build local human

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capital. Many strategic insiders assign expatriates to mentor high-potential Chinese managers by “shadowing” them one-on-one, rate their expatriates’ ability to develop local managers as part of their performance review, and add a completion bonus for such development in expatriates compensation. Nortel, for instance, even sends executives abroad to serve as “coaches,” with no duty beyond developing local talent. IBM frequently drafts its best engineers from its plants and labs in Italy, Japan, New York, and North Carolina to run 3–6 months training courses on all operations carried out at its Shenzhen unit. After the trainers left China, they stayed in contact with their trainees, so local talents can receive continuous support and coaching. Finally, social capital remains a fundamental competence to all businesses in China. Even though tangible business track records and the aforementioned competencies have become increasingly important, social capital in the form of healthy, legitimate and sustained interpersonal and interorganizational relationships with societal stakeholders such as regulators, officials, buyers, suppliers, competitors, distributors, creditors, media, support service providers, and local community remains an important factor for success in China. Such relationships literally bind millions of Chinese firms into a social and business web and can, though not always, reduce transaction costs and information costs or enhance government support and operational stability. To develop social capital, strategic insiders have established government- or public-relations departments at their umbrella centers. Apart from building interpersonal and interorganizational relationships, social accommodation and organizational credibility are also major building blocks of social capital. Social accommodation is the extent to which a foreign business is responsive and contributive to the social needs that have significant longterm repercussions for social and public welfare (e.g., education, health, environment, and infrastructure building). Many strategic insiders realize that social accommodation is largely in their own interest because building trust with Chinese people is impossible unless you are no longer viewed as an “outsider.” To increase organizational credibility, many strategic insiders have deliberately invested in and publicly committed to the improvement of their social-responsibility image, adherence to social norms, institutional harmony, corporate reputation, customer loyalty, solidity of relations with local community, and reciprocal support with network partners.

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Shift from competition to coopetition with business community Early generation foreign businesses generally treated their relationship with Chinese government agencies, local suppliers and distributors, and foreign and local competitors in China as contentious, adversary, or competitive. In these relationships, different parties bargained against one another for their respective gains. Because of the new competitive and regulatory landscapes noted earlier, new generation foreign businesses recognize that it makes more sense to look for and benefit from win–win scenarios in which they can get a bigger piece of the market pie not by creating a bigger loss for a contender, but by making the entire pie bigger together, a situation known as coopetition (Luo, 2004). Although foreign businesses still face strong bargaining and competition with rivals, suppliers, distributors, and regulators, competitive collaboration with these stakeholders has become strategic insiders’ dominant strategy today. Overall, coopetition is attributed to increasing interdependence between business stakeholders and heightened needs for collective actions, risk sharing, strategic flexibility, and prompt response to market demands. Such needs are particularly strong in China due to untapped opportunities on the one hand, but joint effort requirements on the other. Accordingly, these companies work together to collectively enhance performance by sharing complementary resources and committing to common task goals in some specific areas while competing by taking independent action in other areas to improve their own performance. Foreign businesses are collaborating with various levels of Chinese government institutions in improving economic infrastructure, industry competitiveness, output productivity, and beyond. Xerox, for instance, helps the government to build and upgrade the copy machine industry by establishing technical, quality, and service standards and by training hundreds of Chinese engineers and technicians. Nokia and Motorola cooperate with the government in developing sophisticated factors such as a skilled workforce, scientific base, and information industry and by building nationwide supply bases, research centers, and innovation facilities. ABB and Philips collaborate with the government in establishing engineering schools or programs in order to provide the steady flow of talented scientists and engineers needed

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by the industry. Competition, of course, inevitably remains at all times because some clashes of interest inescapably exist since economic and social goals sought by the government are not always complementary to foreign business interests. Foreign businesses seek to maximize risk-adjusted net returns, which may conflict with the government’s interest in social equity, economic efficiency, natural resource, or pillar sector protection. Coopetition is also embedded in the relationship with local and foreign rivals. Siemens, Sony-Ericsson, Motorola, Fujitsu, and Nokia compete along upstream activities (e.g., WAP technology) and downstream operations (sales and marketing) in China, and meanwhile collaborate in setting the standard for mobile wireless operations systems in the nation. These competitors also work together to improve the infrastructure of China’s telecommunication industry, pressure the government for greater market access, build telecom equipment clusters to enhance efficiency and effectiveness, and educate potential customers about their advanced products. Since these joint efforts benefit all related foreign businesses in the same sector, many strategic insiders have incorporated such coopetition in strategic plans. Cisco, for instance, has collaborated with other leading US technology firms such as HP, Lucent, and 3Com as a part of its China strategy. In one case, Cisco and HP constructed a 14-city subscriber network, with Cisco providing the routers and related software and HP supplying the servers and designing and servicing the system through its local Chinese partner. Coopetition with local rivals is evident. Many strategic insiders have transformed their former competitors into alliance partners. While they still compete in other product or geographic domains, they work together in the form of alliances in certain specific areas. Eastman Kodak has partnered with several former competitors such as Xiamen Fuda, Shantou Era, and Wuxi Aermei, enabling it to better compete against Fuji from Japan and Lucky from China. Similarly, DuPont has transformed its leading local competitors, Shanghai Hua Yi and Asia Pacific Agricultural Chemical Company, into its joint venture partners. Building these ventures not only reduces the competition but allows DuPont to share the partners’ industrial network, market power, customer base, and distribution channels. Gillette did the same way by allying with Shanghai Razor Blade Company, its strongest local rival before the two formed an equity joint venture. While IBM still

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competes against Legend, its most powerful local rival, the companies realize that by uniting, they can strengthen market position and solidify collective power against common rivals. Today, the two firms cooperate to jointly develop storage technologies and sell various new products such as ViaVoice 98. Coopetition with local suppliers also abounds. Despite the fact that profit structure in a buyer–supplier relationship is not always a positive sum, thus resulting in natural conflict in profit sharing, cooperation with local suppliers is often necessary, especially when the supply industry on which the foreign business has to depend is not yet well-developed. Many strategic insiders, especially those in the PC, automobile, wireless communication, and electronics industries, compete with Chinese suppliers to lower down the purchasing costs and speed up delivery, while simultaneously cooperating with the latter to improve input quality, train a supplier’s workforce, and develop quality control systems. Motorola, for instance, budgets US$2–3 million annually to educate and train more than 100 local suppliers about total quality control, customer satisfaction, and lean time management. Finally, coopetition with local distributors is prevalent. Although many strategic insiders are developing their own distribution networks in China as part of value chain localization, virtually no company is single-handedly capable of under taking nationwide distribution due to multi-tier segmentation and regional protectionism. Consequently, strategic insiders still have to work with local distributors to reach massive consumers. Coopetition becomes a viable solution for this purpose because cooperation in the form of longterm distribution agreements reduces logistics costs for both sides, stabilizes downstream operations, and fosters trust between them, while competition in the form of price/fee bargaining allows both sides to act independently in, and motivate them to improve, their main functional areas. Since many local distributors knew little about advanced supply chain management, and thus were unable to provide value-added services typically provided by distributors in a developed market such as client feedback, redistribution, commodity inspection service, and merchandising support, many foreign businesses opt for training long-term distribution alliance partners about IT-backed supply chain system and working together to improve distribution logistics and support services. Some foreign businesses such as P&G, Volkswagen,

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and Unilever set up joint ventures with or acquire their former distributors to better integrate and exploit complementary capabilities on both sides.

Shift from repetition to adaptive diversification At the “foreign investor” stage, foreign businesses generally invested in a single or few joint ventures that manufactured one or two core products with marketing focused on eastern and southern coastal cities and relied heavily on a local partner, especially for sales and distribution. The core product offered in China was typically repetitive to their primary product at home, with no or very little adaptation to local market needs and with very limited geographical coverage. Moving toward the “strategic insider” stage, however, foreign businesses have stepped into what we may call “adaptive diversification” — significantly increasing both the scope and scale of businesses that are tailored to mass-market Chinese consumers in multi-tier regions and guided by a carefully planned yet nationally integrated China strategy. “Diversification” here concerns both product and geographic diversifications; “adaptive” means massive customization or responsiveness to the unique demands of Chinese consumers, which differ from other nations’ consumers as well as the unique utility functions required by Chinese consumers in different tiers or regions of the market. To streamline adaptive and evolutionary diversification, stabilize market share and position, and avoid excessive risk and overcapacity, strategic insiders typically follow three sequential steps in the course of adaptive diversification: tailoring and branding, dominating and volume building, and reinvesting and diversifying. These steps are all coordinated by the foreign businesses’ umbrella centers. Tailoring and branding represents a foreign company’s strategy that emphasizes adaptation and innovation of several top brands that satisfy the unique demands of target consumers, differentiate them from other competitors, and allow them to maintain premium prices and channel goods to modern outlets in the first and second tiers of the market. They assume that it is futile to compete with cheap, poor-quality local goods in the low end of the market. Due to the sheer size of middle-class consumers in the first and second tiers of urban regions, market opportunities abound for this

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adaptive yet relatively focused strategy. Philips, for example, introduced a combination Video-CD player in China in the late 1990s. Although there was virtually no market for this product then in Europe or the United States, the Chinese quickly embraced it as a great two-for-one bargain. More than 15 million units were sold in China in the first three years. Frito-Lay introduced the cool lemon series along with packages featuring pastel colors and blue skies to highlight the cool feeling; this product is the best-selling product in China for PepsiCo. Similarly, KFC — China’s biggest chain with more than 1100 outlets — expanded on its fried chicken staple and converted some 40 percent of its menu items to Chinese flavors. Favorite fixtures include red-hot Sichuan diced chicken complete with traditional tiny bits of bone and a soup make of spinach, egg, and tomato. What these foreign businesses often find after a few years of tailoring and branding, however, is that their sales volumes are not sufficient to compensate for their high overheads, and that their unit sales costs are higher than those of local competitors with high volume and broader portfolios. Moreover, they need to leverage and sustain their already established competitive position that resulted from tailoring and branding to not only compensate for higher costs but also to curb the threats from late entrants. Along with value-chain localization, these foreign businesses heavily invest in capacity, substantially expand business systems beyond product development and manufacturing, aggressively build more subunits in eastern and southern coastal provinces, and commit to advertising, promotion, service, and building sales forces. Increased volume, continued innovation, and expanded value chain functions jointly support a foreign company’s sustained dominance (at least 25 percent market share if deemed to be a dominant player) in the focused sector. For mass-market categories such as food, beverages, or personal care, this implies achieving annual sales in excess of US$1 billion. Although they still focus on coastal provinces, these foreign businesses seek wider geographic coverage, extending from large cities to medium and small cities in these provinces and from upscale outlets to low-end outlets. After dominance and volume growth in a specific sector, foreign businesses further expand via reinvestment and diversification. In the face of emerging and untapped markets within China and increasingly tough competition, foreign businesses continue to improve competence building

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and value-chain localization using corporate capital, fortify their dominant foothold in the first three tiers using retained earnings accumulated in China, and replicate their strength elsewhere in China, expanding into the remaining tiers of the market and inland provinces. Ford, for example, realized that there remains growing potential for its Fiesta and Mondeo sedans after over 10 years of phenomenal growth in China’s auto industry (over 50 percent sales growth in 2002) and hence decided to reinvest US$1.5 billion in the sector over the next few years. Its main subsidiary producing Fiesta and Mondeo is located in Chongqing — a city of 31 million people situated hundreds of miles from the major consumer markets of China’s east coast. By the end of 2003, this subsidiary had established about 38 dealerships and authorized a total of 60, many of which are in inland and western cities. Often, after the dominant position for the core product or business was built, other product or business divisions within a foreign business would follow, mostly by horizontal investment, resulting in diversified multiple businesses operating in China. Most strategic insiders today have a multitude of businesses in multi-tier markets producing high-, middle-, and low-end products, metrically monitored by corporate product divisions and the umbrella centers. Such business, product, and geographic diversifications complement the present competitive landscape, enabling foreign businesses to continually benefit from their dominant position in some focused product–market mix while creating new profit avenues for their future growth.

Shift from alliance building to alliance restructuring Most early generation foreign businesses used alliances, including equity or cooperative joint ventures, as the dominant vehicle to invest and operate in China. These alliances accounted for more than 65 percent of their total FDI in China. Today, however, maturing local companies, more accessible markets, accumulated experience in China, and progress toward a more stable regulatory environment have removed much of the initial rationale for entering alliances. In fact, a growing proportion of FDI is now undertaken through wholly-owned greenfield investment, acquisitions, franchising, and the like. At the same time, many existing alliances, especially those formed in the 1980s, are now being restructured due to various internal or external reasons as markets, partners, competitors, and regulations evolve.

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Often, several individual joint ventures are regrouped or united as a part of a foreign company’s overall global restructuring. Samsung consolidated and combined its two joint ventures, Tianjin Tongguang Samsung Co. Ltd. and Tianjin Samsung Electronic Display Co. Ltd., into one new joint venture. This is a key step in Samsung’s global restructuring to combine the production of TV sets and computer monitors so as to better develop and leverage its LCD technologies. This new united venture is designed to be Samsung’s largest global production base for panel display products. Similarly, Nokia is restructuring its four joint ventures in Beijing to form a new joint venture. In its global restructuring plan, China is designated as one of its five strategic regions, parallel to Europe, North America, South America, and Asia. Because its leading market share in China’s mobile phone market is falling, as its competitors such as Motorola and Sony-Ericsson and local champions such as China’s Bird and TCL are capturing more market share, Nokia is attempting to cost-effectively expedite its product design, production, distribution, and service on mobile phones, as well as its new development and expansion into multimedia and network businesses through the above unification and restructuring. The ownership of many alliances is being restructured due to foreign businesses’ strategic needs for greater control over alliance operations. Foreign businesses are increasing their equity ownership in alliances to become either majority or wholly-owned holders. An alliance between partners whose skills are complementary, goals compatible, and commitment honored can last longer. However, many foreign businesses realize that their Chinese partners do not really deliver, or actually lack, the complementary resources and contributions promised in alliance contracts. Most notably, many local partners fail to demonstrate their skills in successfully distributing and marketing alliance products in the manner foreign businesses anticipate. Now, savvy foreign businesses increase their organizational control over alliance activities, especially marketing, through buying out the Chinese partner and strengthening their sales force as well as cooperating with third-party marketing and distribution agencies. Alcatel, Hitachi, Fuji Xerox, and Unilever, to name a few, have all bought out their local partners’ ownership share after they realized that the Chinese partners could not add the expected business value, particularly in go-to-market access. GM, meanwhile, restructured its alliance Jinbei GM Automotive Co. in Shenyang,

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by taking over the combined 50 percent stake from its local partner and other Chinese government-linked shareholders. After completing the takeover, GM combined Jinbei GM’s sales channels with those of its fast-growing flagship alliance in Shanghai, where it partnered with Shanghai Automotive Industry Corp. (SAIC).

6.2 GUANXI AND FOREIGN BUSINESSES Partner Effect The choice of local partner is likely to influence the degree of adaptability of foreign investment to local environment and business practices. As a result, the linkage between guanxi and foreign business performance can be affected by the mode of entry. Foreign investors can opt for either the joint venture (equity or contractual) or wholly foreign-owned subsidiary as an entry mode upon entering the Chinese market. Although the wholly foreign-owned subsidiary mode has been gaining popularity in recent years, the joint venture remains the dominant mode of entry and accounts for 71.73 percent of the total value of actual FDI in 1994 (News Bulletin, 1995a). In light of this preference for joint ventures, the selection of an appropriate local partner is of fundamental importance to the foreign investor. Indeed, when a foreign firm enters a host country in which the cultural, political, and economic systems differ greatly from its own, it is more likely to cooperate with a local partner which has already developed unique countryor firm-specific skills and advantages that are very costly, if not impossible, to duplicate by a foreign firm. Moreover, according to Buckley and Casson (1988), the greater the complementarity or indivisibility between foreign and indigenous firms, the greater the potential for synergistic effects in a joint venture. Foreign investors who have local partners (joint-venture participants) are more likely to have better access to powerful Chinese guanxi networks than others (wholly-owned investors). These joint-venture advantages can be reflected in cheap and reliable material supplies, market access, preferential tax treatment, low land rent, priority in obtaining infrastructure services, and provision of assistance from the authorities when problems arise. In light of

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these considerations, the relationship between guanxi and foreign-invested enterprise performance will be stronger for joint ventures than for wholly owned foreign firms.

Origin Effect FDI in China originates mainly from two sources: Chinese community investors and Western multinationals. Although more than 40 countries from all over the world have direct investments in China, however, about half of the total FDI in the country has come from the Chinese community territory — Hong Kong & Macau, Taiwan, and Singapore. One primary factor contributing to this situation is the cultural proximity between these business people and their Chinese counterparts. The Chinese commonwealth area nurtures a network of entrepreneurial relationships and an array of political and economic systems that are bound together, not by geography, but rather by shared tradition. Guanxi-based business dealings are not foreign to investors from this area. Indeed, for many generations, emigrant Chinese entrepreneurs have been operating comfortably in a network of guanxi, laying the foundations for stronger links among businesses across national borders (Kao, 1993). As a result, an interconnected yet potentially open system has arisen, which provides a new market mechanism for conducting global business (Copeland and Griggs, 1985). Through wellestablished guanxi networks within China, foreign investors from Chinese commonwealth territories more readily gain access to and benefit more from inside information, scarce resources, and access to controlled industries as opposed to other foreign investors. Thus, the relationship between guanxi and foreign-invested enterprise performance will be stronger for those with Chinese commonwealth country origins than for those with non-Chinese commonwealth origins.

Length Effect Guanxi relationships are highly dynamic and must be continuously reinforced given the mobility of the participant’s position or institution (Alston, 1989).

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It is a long and challenging task to identify influential persons and build guanxi with them or their associates. Given this environment, it appears that foreign investors need time to gradually become familiar with local business practices and progressively build their guanxi networks. Those Foreign Invested Enterprises (FIEs) with a longer presence in the country are likely to have developed a better guanxi network and acquired more experience. Although guanxi may be associated with opportunism, the reciprocity rule precludes the persistence of opportunism in the long run. This is quite analogous to a prisoner’s dilemma situation, where opportunism is not the best solution to repeated games with uncertainty in the long term. As a consequence, those FIEs with longer history in China are more likely to experience a lower level of opportunism and a higher level of trust with guanxi hu. Therefore, those FIEs with greater length of operation in China tend to build a more extensive guanxi network, one which would be, moreover, longer-standing and of better quality. As a result, the relationship between guanxi-based business variables and foreign-invested enterprise performance will be stronger for those with a long history than for those with a short history of operation.

Size Effect The strong value traditionally attached to family ties fosters mutual obligations. People will turn to members of their inner circle of friends and relatives to secure favors needed to facilitate their personal or business dealings. This suggests that Chinese people owe their strongest loyalties to their closest family members and friends. Privately owned traditional Chinese firms built around this closely knit group tend therefore to remain small. Many people realize that, in large firms, personal friendships and loyalties are likely to subvert the organization’s aims (Kao, 1993). Whereas conventional Western wisdom suggests that large firms are better because they profit from economies of scale and scope, many Chinese people believe that firms function best and can benefit most from guanxi when they stay small. Smaller firms enjoy more flexibility and higher effectiveness in weaving and harvesting the guanxi web. As a consequence, the relationship between

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guanxi-based business variables and foreign-invested enterprise performance is likely to be stronger in small than in large foreign-invested enterprises.

Empirical Evidence Recently, Luo’s (1997a) study confirms that different foreign businesses in China with different investment traits have different relationships between guanxi and performance. First, the joint-venture entry mode is positively correlated with venture performance and significantly interacted with guanxi. This interaction is significant to all the FIE performance dimensions taken separately. These results suggest that the joint-venture entry mode facilitates the positive role of guanxi in influencing FIE performance. In other words, the relationship between guanxi and FIE performance is positively mediated by the joint-venture entry mode. Indeed, the joint-venture mode can outperform the wholly-owned subsidiary in boosting the positive effect of sales force marketing on accounting return, market growth, and asset efficiency for FIEs. The selection of an appropriate local partner is thus an essential way to adapt to the indigenous environment and achieve the benefits of guanxi. Second, Chinese commonwealth country of investment origin positively moderates the association between guanxi and FIE performance in a significant way. Cultural proximity is thus an undeniable factor affecting the function of guanxi in FIE performance. Third, the length of operation not only significantly facilitates the relationship between guanxi and accounting- and market-based performance measures of FIEs but also independently affects the foreign venture’s profitability. The learning effect and accumulative nature of guanxi are verified. Fourth, the asset size of FIEs does not significantly affect the role of guanxi in FIE performance. The organizational structure adopted by FIEs for their operations in China often replicates, or at least is quite similar to, the existing structure in their home country. As a result, a smaller size does not necessarily correspond to a more flexible and effective operation. Another possible reason for rejection can be traced to the fact that the benefits derived from guanxi when a venture stays small could be offset, to a large degree, by the disadvantages resulting from reduced capabilities in process

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innovation, product differentiation, and risk reduction. A further explanation may be linked to the increasing tendency for many large Chinese firms, including state-owned enterprises, to build and use guanxi. Indeed, relatives of high-ranking party officials head many of these businesses. Therefore, guanxi exists across firms regardless of firm size. Yeung and Tung (1996) further confirmed the above findings. They find that representatives from Hong Kong firms assigned a higher significance to guanxi than non-Hong Kong firms. This difference may stem from the fact that the Hong Kong firms derived 100 percent of their revenues from China while the non-Hong Kong firms were more diversified in their investment portfolio. For the non-Hong Kong firms, revenues from their China operations accounted for 5–45 percent of their total sales from the Asia-Pacific region. They also find that firms in the tertiary and exporting sectors assigned greater importance to guanxi than those engaged in manufacturing and importing. This appears to stem from the fact that firms engaged in manufacturing and importing were more localized in their operations. Once they were established in a specific business location, they did not have to expand and shift their guanxi networks continuously. Those in the tertiary and exporting sectors had to frequently broaden their base of operations and search for new suppliers.

6.3 IMPLICATIONS AND EXAMPLES Foreign investors can gain an edge over their competitors by understanding and incorporating the guanxi factor in their business decisions. Understanding Chinese guanxi will assist foreign investors in formulating and implementing realistic business and investment strategies tailored to the Chinese context. As the privatization and opening up of the Chinese economy proceeds unabated, it will be a challenge for scholars and an imperative for investors to follow the evolving role of guanxi.

Minicase 1: Hewlett-Packard’s Initiatives to Build up Guanxi William Hewlett and David Packard founded Hewlett-Packard in 1939. The company designs, manufactures, and services electronic products and

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systems for measurement, computing and communication used by people in industry, business, engineering, science, medicine, and education. The company has more than 25 000 products, including computers and peripheral products, electronic test and measurement instruments and systems, networking products, medical electronic equipment, instruments and systems for chemical analysis, handheld calculators, and electronic components. Hewlett-Packard is No. 16 on the Fortune 500 list of the largest US corporations and is one of the largest computer companies in the world. The company had net revenues of US$38.4 billion in its 1996 fiscal year. More than 55 percent of its business is generated outside of the United States, and more than two thirds of that is in Europe. Other principal markets include Japan, Canada, Australasia, the Far East, and Latin America. Hewlett-Packard is one of the top 10 US exporters. China Hewlett-Packard (CHP) was set up in June 1985. It was the first Sino–American high-tech joint venture in China’s electronic industry. CHP now has over 820 employees in sales, marketing, support, manufacturing and research and development. Products sold in China include test and measurement instruments, computers and peripherals, medical equipment, analytical instruments as well as components. CHP its headquarters in Beijing. It also has branch offices in Shanghai, Guangzhou, Chengdu, Xian, and Shenyang. CHP has proven to be very successful and has been rated by the Economy Daily as one of the top 10 joint-venture companies in China for six consecutive years. In recent years, it has had a compounded annual growth rate of 50 percent. CHP has six sales offices in Beijing, Chengdu, Guangzhou, Shanghai, Shenyang, and Xian. It has two manufacturing operations in Shanghai (China PC Manufacturing Operation) and Beijing (China Test & Measurement Operation). The seven joint-venture manufacturing companies are HP Medical Product (Qingdao) Co. Ltd.; HP Shanghai Analytical Products Co. Ltd.; Huapu Information Technology Co. Ltd.; Putian OEM System Integration Co., Ltd.; Huatek Software Engineering Co. Ltd.; HP (China) Investment Ltd.; and HP Computer Products (Shanghai) Co. Ltd. China Hewlett-Packard was the first Sino–American high-tech joint venture in electronic industry in China. As a first mover, it enjoys special privileges from the Chinese government.

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HP is one of the top computer service and support companies in the world. It is the first major company to introduce a number of computers based on an innovative technology known as reduced-instruction-set computer (RISC). HP is now the world’s No. 1 revenue leader for RISC systems and UNIX system-based computers and the world’s No. 2 supplier of powerful workstations for engineering and business applications. HP’s continuing growth is based on a strong commitment to research and development. Each year the company invests about seven percent of its net revenue in R&D (US$2.7 billion in 1996). This heavy investment, coupled with an ability to manufacture and market leading-edge technology quickly, lets HP provide a steady flow of new and useful products. Its high technology and strong R&D are highly demanded by the Chinese government. The company’s entrepreneurial flexibility is fostered by a decentralized organization that gives business units considerable decision-making authority. CHP has its own autonomy to produce products that are suitable to the Chinese market. HP has good management and experienced engineers to help its operations in China. Hewlett-Packard has an international reputation as one of the world’s largest computer companies and is ranked No. 16 on the Fortune 500 list of the largest US corporations. It has overseas experience in Canada, Japan, Australasia, the Far East, and Latin America and it has a strong financial background. HP’s willingness to offer a long-term partnership with China, to provide assistance in “the four modernizations,” and technological transfer is a firm relationship base with the Chinese government. Guanxi is one of the major dynamics in Chinese society and influences all business behavior. The computer industry is no exception. By developing and maintaining a good relationship with China, doing business is much easier. CHP has taken several initiatives to develop and maintain guanxi in China. These involve: 1. Support of China’s Telecommunications Industry: CHP has intensified cooperation with the Chinese government in the field of telecommunications and has participated in creating several telecommunications standards for the Chinese government. It further cooperates with the Ministry of Posts and

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Telecommunications and other government agencies for telecom equipment supply and application development. 2. HP China Focus Plan: Under HP’s China Focus Plan, HP will increase its service staff in China in order to set up a complete service support system. HP will also make efforts toward product localization to “Chinesize” its network management system. As part of the China Focus Plan, HP Technology Center opened in Beijing in July 1996. Hewlett-Packard invests US$6–$7 million a year in the research and development center to provide professional services and support for its clients in China. The established technology center demonstrates HP’s latest hardware and software and provides advice for customers in almost all sectors, especially in the four major fields of telecommunications, finance, manufacturing, and engineering design. 3. Joint R&D Center: Hewlett-Packard and the State Science and Technology Commission of China (SSTCC) opened a joint-research facility in the Haidian District called High-Technology Research and Development Center (HTRDC) in 1997. Establishment of the research center represents a move away from the previously segmented and distributed research cooperation to one that is more centralized, more efficient, and that can more easily manage and better support various R&D efforts. SSTCC and the HP entities supporting this new research — HP Asia-Pacific, HP Laboratories, HP’s Test and Measurement Organization’s Microwave and Communications Group — will focus their cooperative R&D efforts on mobile communications and multimedia, in response to a growing demand for telecommunication and multimedia solutions in China and around the world. Cooperation with SSTCC will strengthen HP’s connection with the Chinese government. The purpose of the cooperation is also to make use of the development and marketing experience of Hewlett-Packard, and engineers and researchers available in China to develop advanced technology that can be incorporated in products and introduced into the marketplace by HP and by Chinese organizations. This collaboration is expected to result in jointly owned intellectual property and commercial products to be marketed separately by both organizations. It is also expected that China’s collaboration with HP will lead to improvements in the quality of Chinese management and

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focus on the process of technology transfer. This joint venture will be used as a model for similar relationships with other international corporations. 4. Hewlett-Packard and SAIF: formed a joint venture with the Shanghai Analytical Instrument Factory (SAIF) in Shanghai in 1995 to focus on R&D, manufacturing, for the production and customer support of SAIF analytical chemistry instrument products, which include gas chromatographs, liquid chromatographs, UV/visible spectrophotometers, and atomic-absorption instruments. After technology enhancement from HP, the products will eventually be sold in other countries. The joint venture is to show the Chinese government HP’s commitment to establish a major presence in the analytical instrument industry in China. China can also use this opportunity for technology transfer. 5. HP China Medical Division: HP China Medical Division is a joint venture of the HP Medical Group and China National Corporation of Medical Equipment Industry. It was formed in 1997 and it provides medical technology designed specifically to meet the needs of doctors, clinics, and hospitals in China, and eventually in other emerging markets around the world. The creation of the division reinforces HP’s commitment to the Chinese market and will allow HP to locate design and marketing teams to meet the distinct needs of China’s medical professionals and provide the resources and independence necessary to fulfill the Chinese market. 6. HP’s Contribution to China’s Sustainable Development Networking Program: The goal of China’s Sustainable Development Networking Program (SNDP) is to create a structure which will enable sustainable development activities throughout the country by simplifying access to information and encouraging information sharing at all levels. In particular, international work on sustainable economic development will be made available to China; and China’s work on Agenda 21 will be shared with the international community. All sectors of society, including governmental agencies, the private sector, academia, research institutions, and non-governmental organizations will be given access to information sources worldwide which will help them in their efforts to create long-term solutions for China’s problems. Technical training on network use and management, databases, and other skills is also an integral part of this program.

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To support this program, Hewlett-Packard provides SDNP China with a broad range of equipment, software, and services designed to meet the need for a high-performance network infrastructure which is robust, scalable, and easily managed. HP also oversees the installation of two new HP Domain Enterprise Servers which are used by SDNP personnel to store and develop the enormous amounts of information which are used to guide the development of sustainable economic, environmental, and social programs into the next century. HP also supplies PCs, laptop computers, printers, and other equipments designed to support and expand the capabilities of HP Domain Enterprise Servers. To ensure that end users at SDNP’s Beijing office are fully proficient with the new equipment, HP provides support and training for all donated software and hardware. In sum, Hewlett-Packard has worked very hard during the past 13 years to develop and maintain guanxi with China. The result has proven to be satisfactory. In 1996, Hewlett-Packard ranked number 11 on a list of the top-12 US companies with the biggest stakes in China. This again proves that guanxi network is very important for doing business in China.

Minicase 2: Boeing in China So far this year, Boeing Co. salesman Lee Hsiung-Fei has made four trips to the remote southwestern Chinese city of Kunming to cultivate tiny Yunnan Airlines. He has gotten to know everyone from line mechanics to pilots. And when Yunnan Air took delivery of its first 767-300 in August, Lee didn’t stop with the customary banquet in Kunming. When some 20 Yunnan pilots, engineers, and managers flew to Seattle to take delivery, Lee took them sightseeing in the Pacific northwest, shopping in Seattle, and hosted them in his home. “It’s important to get to know the airline at every level, down to the foot soldiers,” says Lee. With a fleet of 11 planes, Yunnan is hardly a glamour customer of global aviation. But thanks largely to the smothering attention of Lee and his colleagues, Yunnan, like most of China’s 32 airlines, has been loyal to Boeing. The Seattle giant is determined to keep it that way. With plans to

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spend US$100 billion on some 800 aircraft over the next 15 years, China is the linchpin in the no-holds-barred battle between Boeing and Europe’s Airbus Industrie to dominate Asia, which is expected to account for 40 percent of world aircraft sales over the next decade. While Boeing’s global market share is about 60 percent, in Asia, it’s closer to 70 percent. And since suffering some serious setbacks in 1994, when Airbus snared big orders from such key customers as Cathay Pacific Airways Ltd. and Singapore Airlines Ltd., Boeing has been on a roll. It has scored multibillion-dollar orders not only from Hong Kong-based Cathay and Singapore but also from the flag carriers of Indonesia, Malaysia, Thailand, the Philippines, South Korea, and the three airlines of Japan. Of the 281 long-haul 777s sold worldwide since 1990, Asia has purchased 148. A key reason is Boeing CEO Philip M. Condit’s decision to give customers a say in the 777s design. Asian airlines were behind major decisions, such as making the plane longer and wider than first planned, and trifling ones, such as developing a toilet seat that closes silently. The 777-300, a stretch version with more than 400 seats that costs ten percent less to operate than a 747-400, was made expressly at the request of Asian carriers. “Phil Condit has done a terrific job of getting Boeing to focus on costs and involving the customer at every stage of development,” says Cathay Pacific Managing Director Rod I. Eddington. “This absolutely made a difference in Cathay’s decision to buy 777s.” The 460- and 550seat derivatives of the 747 that Boeing is now developing also grew out of demand from Asian carriers. Across Asia, however, Airbus is turning up the heat. In April, it struck two key deals in China, where its market share had been minuscule. First came a US$1.5 billion order for 30 jets, signed by Prime Minister Li Peng during a state visit to France. Then, Beijing announced that it would team up with a European consortium that includes Airbus partners to build 100seat aircraft, a project that Boeing had bid on. Meanwhile, Beijing postponed purchases of up to US$3.5 billion in Boeing planes, partly to retaliate against Washington’s tough stance on trade and China’s menacing war games in the Taiwan Straits. The delay signals that unless relations improve, the US industry will pay. And no matter how solid Boeing’s support may be among China’s airlines, the government is

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not about to allow one manufacturer to monopolize its industry. Larry S. Dickenson, Boeing’s vice-president for Asia sales, calls the bilateral tensions “a windfall for Airbus.” But there are also signs that Airbus is closing the loyalty gap. Things started improving in 1994, when it opened a Beijing office and beefed up its Chinese marketing and technical services staff. The company now has 92 employees on the mainland, half of them Chinese, with orders to visit every airline at least monthly. Next year, it will open a US$50 million parts-distribution and training center in Beijing. Rolf Rue, President of Airbus Industrie Beijing, confidently predicts that Airbus will land up to 40 percent of China’s new orders. In April, Airbus also scored a landmark deal by selling three A320s to Guangzhou-based China Southern Airlines, the mainland’s most ambitious regional airline. China Southern is a key Boeing customer, the first mainland carrier to order 777s. Boeing executives are convinced that China Southern bought the Airbus planes under orders from Beijing. Last year, they claim, the carrier decided to purchase 35 737-300s, but the government wouldn’t sign off on it. Airbus says China Southern simply decided that the A320 was a better plane. “Boeing’s complaining merely demonstrates how out of touch they are with their customers,” says Rue. China Southern declined to comment. In any case, it will be enormously difficult to unseat Boeing, which is unrivaled among multinationals at building guanxi, or relationships, in China. Ever since Boeing sold China its first 707s in the early 1970s, its sales representatives have kept up ties with far-flung aviation officials, pilots, and mechanics. Over the past two years, Boeing has invested US$150 million to beef up sales, maintenance, and training operations across China. It has opened a headquarters in Beijing with about 50 customer service staff and is setting up a huge parts-distribution center outside Beijing’s Capital Airport. The company has been helping China develop a modern air-traffic-control network, has donated flight simulators worth US$25 million to training colleges, and has helped numerous airlines set up maintenance departments, computerized parts-inventory control, safety programs, financial management, and even in-flight training programs. Since 1993, Boeing has taken more

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than 1000 mainland mechanics and pilots to the US for training. Last year alone, it hosted 3500 Chinese visitors in Seattle. Beijing has made its appreciation clear. In one meeting, Chinese economic czar Zhu Rongji assured Ronald B. Woodard, President of Boeing’s Commercial Airplane Group, that the company “will enjoy a long and prosperous future in China.” But Chinese leaders have also made it clear that Airbus will be playing a larger role. That should guarantee that Boeing’s future in Asia will also be marked by long and vicious competition. Source: Adapted from Pete Engardio, “The Relentless Pursuit of Guanxi”, Business Week, September 30, 1996, p. 124.

Minicase 3: Foreign Firms are Still Welcome to and in China The executives of foreign firms with operations in China grumble that their lives have got harder of late. China used to be a frontier market offering endless double-digit growth. Officials put out the welcome mat, and were open to wining and dining. Regulators were no more bothersome than in other emerging markets. Now, growth is slowing: official data released this week confirm that the economy grew by 7.4% last year, the slowest rate in 24 years. A crackdown on official corruption has made it impossible to win friends in government. And antitrust authorities have taken a tough line with foreign carmakers, drugmakers, and other firms that had hoped their guanxi (connections) offered them protection. Many foreign bosses are now convinced that the golden age for multinationals in China is over. That may explain the charm offensive the government launched this week. The Prime Minister, Li Keqiang, led, a delegation of Chinese worthies to the World Economic Forum’s meeting in Davos, Switzerland. He promised the assembled global business elite his country would “treat Chinese and foreign companies as equals” and “rigorously reject protectionism”. Ahead of his speech the government unveiled a dramatic proposal to ease its restrictions on foreign investment. Over the past two decades, China has maintained a highly restrictive, complex set of rules on how foreigners can invest on the mainland. In the many industries deemed “strategic”, for

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example, they must invest only through a joint venture and must transfer technology to the local partner. Flows of funds in and out of the country are also tightly controlled. The draft reforms, which are now open for comment, include scrapping almost all of these cumbersome controls. Foreign firms would supposedly be treated the same way as national ones. The clunky system of case-bycase approvals will be replaced by a simpler “negative list”: if your industry is not on it, you do not need permission to invest. Daniel Roules of the Shanghai office of Squire Patton Boggs, an American law firm, believes the new law — if and when it comes into force — could usher in a significant and welcome change in the climate for foreign firms. Mr. Li is also pushing for bilateral investment treaties with the United States and the European Union, which could further reassure foreign investors worried about putting more money into China. His boss, Xi Jinping, agreed a sweeping free-trade agreement with Australia on the heels of the recent G20 summit in Brisbane. This provisional deal, which must now be ratified, goes much further than previous accords in opening up China’s service industries to foreign investment. Taken together, foreign direct investment (FDI) into China, fostered also in part by China’s new foreign investment law that better policy treatment and property protection for foreign firms, will continue to grow. Nevertheless, foreign businesspeople should not break out the champagne yet. The proposed reforms are a strong signal that foreign money will continue to be welcome in China. However, they may do nothing to help foreign-owned firms compete on equal terms with politically well-connected domestic ones, to end the subsidies lavished on state-backed enterprises, or to rein in regulators keen on bashing outsiders. The areas of business most tempting for foreigners, such as finance and the internet, will still have restrictions on foreign ownership. If China’s leaders were to take on all these distortions, then they would get a far warmer round of applause at their next Davos appearance. Source: Adapted from The Economist, 2015.

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7 GUANXI, CORRUPTION, AND GOVERNANCE

The “red envelope” culture is now popular and pervasive in China and beyond, a situation which calls for a distinction between guanxi and corruption. This chapter thus aims to address several critical issues pertaining to business implications of corruption. The first section defines the concept of corruption and explains the differences between guanxi and corruption. Corrupt activities, types, and reasons as well as moral degradation are described in the following sections. The next section presents economic rationalities and implications of corruption and identifies and elaborates business implications of corruption. We argue that, at the organizational level, corruption is an evolutionary hazard, strategic impediment, competitive disadvantage, and organizational deficiency. Practical examples are provided in the last section.

7.1 NATURE OF CORRUPTION Definition With respect to the definition of corruption, researchers in political science generally focus their attention on transactions between private and public sectors which illegitimately convert collective goods into private payoffs. Under this seemingly obvious consensus, however, no particular definition of corruption enjoys substantial agreement among social scholars. As Halayya (1985) commented, “Everyone knows what corruption is; but it is difficult to define it in exact terms.” Nevertheless, researchers have made great endeavors 203

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to search for a universal definition of corruption. Emphasizing the actor, Ekpo (1979, p. 3) defines corruption as role behavior in political institutions which violates formally defined role obligations in favor of personal roles that are intra-organizational. From the perspective of motivation, Brooks (1974, pp. 41–54) defines corruption as the intentional misperformance or neglect of a recognized duty, or the unwarranted exercise of power, with the motives of gaining some advantage more or less directly personal. Nye (1967, p. 419) conceptualizes corruption as behavior which deviates from the normal duties of a public role because of private-regarding (personal, close family, private cliques) pecuniary or status gains; or violates rules against the exercise of certain types of private-regarding influences. Focusing on the consequence, Friedrich (1966, p. 74) holds that corruption exists wherever a power holder is induced to take actions which favor whoever provides the rewards and thereby does damage to the public and its interests. As Gong (1994) correctly pointed out, corruption is not a static notion, but a dynamic one which evolves over time and differs from society to society. This means that it is difficult and unrealistic to provide a universal, operational definition of corruption. Broadly, however, a philosophical definition can be made. In light of the insights of previous studies while dismantling their limitations, this book defines corruption as individual (especially bureaucratic) behavior which deviates from the norm or violates rules specified by a given political context, with the motives for private gains accrued from his or her public roles. According to this definition, the concept of corruption includes the following natures: First, corruption is perceptual. It relates to individual behavior as perceived by public as well as political authorities. Since it is a perceptual term judged by others, the concept becomes dynamic, subject to changes in social attitudes and political ideologies. As such, corruption can be further classified into “white”, “black”, and “grey” types. Although all violate legal codes or institutional rules, each of these has different moral implications. While “white” corruption, i.e., some types of misconduct, can be tolerated by mass opinion, “black” corruption is clearly condemned. In between falls “grey” corruption which is often ambiguous. Accordingly, the legal definition of corruption remains important for “black” and “grey” corruptions, the role of legal definition of “white” corruption is diminished.

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Under certain circumstances, the public may reasonably feel that an act which is legally defined as corruption is nevertheless a necessary tool to survive. This explains in part why anti-corruption laws and rules in many dynamic countries such as China have been changing so rapidly. The nature of “perception” is even more prominent when one considers the dynamic nature of “norm,” “duty,” and “rules.” Second, corruption is contextual. Depending on the individual, ideology, paradigm, culture, or other context, the term “corruption” can mean different things to different people. It is particularly important to take into consideration the impact that the changing political environment may have on the term. Politics not only affects the understanding and explanation of corruption, but also produces and identifies certain social behavior as corrupt. Therefore, it is necessary to examine not only corruption practices per se, but also the attitude and performance of the political system toward corruption such as the exposure of corruption by press, by the party in power, by different factions, as well as the reaction of government to corruption, whether administrative or judiciary. Third, corruption is power-related. In order to be eligible for a corrupt transaction, a corruptor or bribee must necessarily be in a position of power, created either by market imperfections or an institutional position which grants him or her discretionary authority. Private, nongovernmental officials could also be the recipients of bribes. Corruption always depends on power; power, however, may or may not depend on a law. This may be market power, for instance, when a purchasing agent for a monopoly overinvoices his transactions and the lack of yardstick comparison disguises his corruption. Power does not have to spring from the law. Having said this, nevertheless, bureaucratic corruption, i.e., those corruptions involving governmental officials, constitutes the most corruptible and corrupted part in many societies, especially in developing or transitional economies. Fourth, corruption is illegal or norm-deviated. Although corrupt behavior can arise in a number of different contexts, its essential aspect is an illegal or unauthorized transfer of money or an in-kind substitute. Although there may be a situation where certain behavior is generally considered as corruption but no legal precedent has been established for it (in this case, the legalist definition lags behind moralist definition), legality-based norms

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are most widely used. This is because the legalist definition of corruption is generally more operational, clear-cut, consistent, and precise than the moralist definition. Moreover, it usually does not take long for judiciary rules or institutional stipulations in a given political context to “catch” up through the modification of the legal framework. The person bribed must necessarily be acting as an agent for another individual or organization since the purpose of the bribe is to induce him to place his own interests ahead of the objectives of the organization for which he works. In general, corruption leads the corruptor to secure private gains at significant public expense. Although not all corruption will definitely be detrimental to social welfare, it violates legal codes or institutional rules stipulated in a given political context. Without this essence, corruption cannot be distinguished from gift-giving and guanxi. Fifth, corruption is intentional. The motivation of making personal gains conveys the very connotation of corruption. Illegal misconduct may not necessarily be corruption if there is no personal gain. Economists generally treat corruption as another means of maximizing profits or seeing optimal economic resources. Addressing its sensitivity to the rationality that underlies corruption enables us to differentiate purposive dereliction of duty for personal gain from other careless maladministrative behavior. Sixth, the function of corruption is either to strengthen existing groups or to disrupt them. Corruption always involves at least two actors because it maintains groups as interlocking gears for its existence. Over time, it stabilizes a group because it creates internal bonds. Members of the corrupt clique tend to help each other. It can also be disruptive in the sense that it brings about disunity and distrust in the group when the participation in corrupt practices is not the intention of every member of the group. Lastly, corruption’s mode of expression is almost always covert. Because of the nature of the operation, it is hidden, veiled, underground in the informal arena. No formal written contract is delivered: contact is through oral communication so that it cannot be documented and used to prosecute an individual. Maneuvers are carried out behind the scenes to conceal the identity of the actors. Overall, corruption is an informal, veiled system transforming benefits derived from one’s public roles and power to personal gains. On the other hand, corruption is produced by the

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rigidity of the formal system; it unblocks and speeds up the process of the system. But it also produces the formal system. It fills the interstices of the formal system, allows its decomposition, and provides new impetus for its recomposition. Corruption brings both money and power and repositions factions. Corruption also reproduces itself over time because the agents recruit members according to the law of supply and demand. The inflexibility of the formal system causes actors to bring their corruption schemes into the underground, where they are protected by secrecy and where they can flourish and reproduce themselves in the shadow of the formal system.

Differences between Corruption and Guanxi The above illustration provides a foundation to distinguish between corruption and guanxi. As indicated in preceding chapters, guanxi refers to the concept of drawing on connections in order to secure favors in personal relations. It contains implicit mutual obligations, assurance, and understanding and governs Chinese attitudes toward long-term social and business relationships. While it includes reciprocal obligations to respond to requests for assistance, this reciprocity is implicit, without time specifications, unnecessarily equivalent, and only socially binding. Guanxi provides a complement to contract law, and obligations mainly come from relationships. The following differences between the two concepts are accordingly outlined. First, guanxi is an ingredient of social norm whereas corruption deviates from social norm. Favor exchange on the basis of implicit, social reciprocity has long been an important component of the Chinese culture. It redresses deficiencies of laws and law enforcement and facilitates social and economic exchanges in people’s life. Corruption, however, deviates from both the normal duties of a public role and the commonly accepted social standards. While people commend skillful guanxi developers, they condemn corrupted bureaucrats. Although corruption and graft were certainly not a rare practice in China, corruptors or bribees were always condemned in the history of the Chinese society. In general, corruption is the moral incapacity of citizens to make reasonably disinterested commitments to actions, symbols, and institutions which substantively benefit the common welfare. This moral incapacity comes from the interaction of human nature with systematic

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inequality of wealth, power, and status. Such disparities, spawned by the human capacity for selfishness and pride, can generate systematic corruption. The privatization of moral concerns and the accompanying breakdown of civic loyalty and virtue are the cardinal attributes of a corrupt state. Second, guanxi is, in general, legal, whereas corruption is illegal. Just like tax avoidance is legal while tax evasion is illegal, guanxi and corruption may share certain common tactics or methods behind the practice (e.g., gift-giving) but differ essentially in judiciary implications. As a dominant part of business culture, guanxi complements law and stipulates business success. It may even boost the national economy if bureaucratic efficiency is not obstructed and institutional framework is not contagious by pervasive use of guanxi. Corruption, however, creates a serious risk of marginalization in the global marketplace. It threatens to erode already waning support for development assistance to governments. It jeopardizes private sector investment and hinders economic growth. It further imposes a disproportionately heavy burden on the poor. Corruption does not complement but rather deters and contaminates the legal framework in a given political context. Third, guanxi essentially builds on favor exchange whereas corruption mostly involves monetary exchange. During interpersonal exchanges of favors, renqing arises when one provides a favor or help to the other. While Chinese people weave networks of guanxi, they also weave webs of renqing obligations, which in turn provide the moral, implicit foundation for the social reciprocity in the future. Failure to comply with this reciprocity in the future, despite the lack of time specification, will tremendously impede one’s social status and reputation (i.e., “face”). By contrast, the primary instrument used for exchange during the corruption process is money or high-value items. Exchanging money with power is the most notable form of corruption in China and elsewhere. In fact, the prominent determinant underlying the judicious decision in Chinese courts about how a corruption criminal should be lawfully punished is the amount of money or the value of precious or luxurious items. Fourth, guanxi involves implicit, social reciprocity whereas corruption pertains to explicit, transactional reciprocity. Guanxi is embedded in renqing formulation as an endless flow of interpersonal exchanges and reciprocal

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commitments. On the contrary, corruption is normally a deal between a briber and a corruptor. Such a deal is transactional in the sense that the terms of payment by a briber and the service by a corruptor are explicitly, orally specified. As a result, monumental corruption destroys human values in a clear-cut manner. Unlike guanxi, a perpetual flow of favor exchanges, corruption is a one-time deal. Once this deal ends, no unpaid social obligation (i.e., renqing) remains for either party. Fifth, guanxi does not involve any lawful risks if it fails, whereas corruption is linked to high legal risks and uncertainties. When a guanxi relationship breaks, it has only social consequences. That is, the person who fails to comply with guanxi principles will lose that particular network, perhaps forever, as well as his or her social reputation. When this good reputation is lost, he or she will have to pay significantly higher expenses to develop new guanxi connections in society. In contrast, a corruptor always encounter high risks of being put in jail when he or she plunges into corruption activities. When a corruption deal is broken, this risk multiplies. Sixth, guanxi builds on a long-term orientation whereas corruption deals with a short-term “transaction.” Guanxi is established and reinforced through continuous, long-term association and interaction. People in Chinese society assume the interdependence of events, understanding all social interactions within the context of a long-term balance sheet. Some guanxi connections continue from generation to generation and never end. By contrast, corruption is a one-time shot involving short-term gains for a specific business. It is often seen as an isolated occurrence emphasizing immediate benefits from the exchange. Although some corruption relationships can also be continuous between the same actors, they usually reside in repetitive businesses in which corruptors keep receiving “red envelopes” for every “service” they provided. Due to the absence of trust, such relationships are not sustainable. According to game theory, Nash equilibrium can never be reached in the case of corruption because both actors doubt whether the counterpart will comply with the rule of “game.” Corruption is an uncertain game in which information is never symmetrical, complete, and perfect. Seventh, guanxi does not specify a time limit, whereas corruption often requires timeliness. Guanxi is an implicit, reciprocally committed interpersonal connection. This reciprocity, however, does not stipulate

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any time period during which certain favors or help must be returned. A corruption deal, however, usually spells out the “expiry” by which a corruptor’s “service” must be fulfilled. He is obligated to this timeliness which is a precondition for his private gains. Failures to satisfy a briber’s time request will certainly jeopardize his public role. Just like the clause of delivery in product transactions, time specification and implementation is a material term in corruption. Eighth, guanxi builds on trust whereas corruption is based on “commodity.” Trust is an important element of a sustained guanxi relationship and limits the likelihood of opportunistic behavior. Although credibility is embedded in social relations, its underlying rule grants those who apply it a sense of moral superiority, honesty, and integrity, which is key to guanxi maintenance in the long run. By contrast, a corruption relationship is established based on “commodity” exchange between money and power. Power can easily transform to commodity when governmental, institutional, and judiciary systems are all corrupted. While the value of guanxi is generally determined by trust, the price of corruption is often determined by power. Lastly, guanxi is transferable whereas corruption is not. Since guanxi builds on trust, interpersonal networks always expand through credible intermediaries. This transferability explains why relational networks in China are so pervasive and complicated, or what Chinese people called “with twisted roots and gnarled branches.” Corruption, however, is not transferable. Instead it is generally a covert, hidden, only between-you-and-me type of interaction. During the corruption process, the fewer people involved, the safer the “business” is, therefore the less likely to engage in criminal fraud. Because of the illegality of corruption, transferability increases the divulgence risk, and thus the corruption costs.

7.2 CORRUPTION IN CHINA Current Situation Wherever you look these days, there are headlines about the curious way in which some people use other people’s money. The European Parliament

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has stirred itself to take a serious look at the sleaze which goes on under the European Commission’s too often undiscerning nose. Some of the locals who were keen that the 2002 Winter Olympics should take place in Salt Lake City are accused of having used bribery to get their way. On a rather larger scale, the question of how Indonesia’s President Suharto had piled up so much wealth was one of the chief causes of the demonstrations that pushed him out of power in 1998. Several thousand miles away, on another continent, Zimbabwean students put the same question to their own leaders. “If Indonesian students did it we can do it,” read one of their placards. In the 1990s alone, governments in Italy, Brazil, Pakistan, and Zaire have fallen partly because the people they governed would no longer tolerate the corruption of politicians. It is not the first time that the people have mutinied. Imelda Marcos’ amazing shoe collection enraged Filipinos in the early 1980s every bit as much as the high living of Mr Suharto’s children infuriated Indonesians. But a concerted attempt to bring corruption under control has at last become possible because the indignation of ordinary people has been reinforced by an alliance of aid donors, lawmakers, and businessmen who had previously (at best) just wrung their hands. In Albania, businesses pay an average of eight percent of their turnover in bribes, about a third of their potential profits. In Indonesia pungli, the payments that enterprises make to keep bureaucrats off their backs, add up to about a fifth of total operating costs. All these generate vast incomes for politicians. According to one estimate, not long ago African leaders, had US$20 billion on deposit in Swiss banks alone. German businesses are reckoned to pay more than US$3 billion a year to win contracts abroad. In the international arms trade, probably the world’s dirtiest legitimate business, one estimate reckons that roughly US$2.5 billion a year is paid in bribes, nearly a tenth of turnover. Corruption has been one of the central factors affecting China’s social stability, structural reform, and economic development for many years. In 1998, Chinese prosecutors handled 108 828 cases of bribery and dereliction of duty and investigated 40 162 persons. Nine thousand three hundred and eighty-nine of these cases were “spectacular cases,” that is, each of which involved bribes of more than 50 000 yuan (US$6024) or the embezzlement of public funds worth more than 100 000 yuan (US$12 000). They involved

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some 1820 officials above the county level and 7065 staff members in judicial and administrative offices. The case of former Beijing Mayor Chen Xitong demonstrated the determination of the Party and the government in the anti-corruption campaign. Prosecutors had joined the anti-smuggling movement as well, handling 8469 cases of smuggling and foreign currencyrelated crimes, involving 14 554 persons in 1998. Corruption activities are even greater in several regions. In Sichuan province, for instance, some 1000 officials above the county level were prosecuted for corruption over the past decade based on tips received from local residents. The province opened its first Anti-Corruption Reporting Center in 1988. Prosecutorial departments throughout the province have investigated 5000 cases involving bribery and embezzlement. Related departments have completed investigation of some 983 officials holding positions above the county level. The departments have not only brought corrupt officials to trial, but have also helped recover government funds of well over 800 million yuan (about US$100 million). In addition, prosecutorial departments have “rewarded” over 4000 tipsters. Some 200 reporting centers in the province currently employ over 600 people. In Guangdong province, prosecutorial departments investigated 1483 cases of corruption involving 1766 officials during 1998. These investigations focused on smuggling cases involving government officials and corruption in the administration, finance, taxation, and foreign exchange sectors. Some 139 cases involving funds of over one million yuan each have been prosecuted, along with 1334 corrupt officials. According to the statistics released at the Third Plenary Session of the Central Commission for Discipline Inspection in Beijing in January 1999, out of 158 000 Party members who were penalized by the end of December 1998, 5357 were officials at the county magistrate level, 410 were above the prefecture commissioner level, and 12 were above the provincial governor level. Prosecutors across China have placed 35 000 cases on file, of which 10 000 are key cases. Officials involved in these cases included 1820 officials at or above the country magistrate level. The People’s Courts have tried 33 000 economic cases, 19 500 of which were cases of corruption, bribery, and dereliction of duty. The state has banned the People’s Liberation Army, the armed police, legal organs, and Party and government departments from participating in business activities.

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Redoubled efforts from China’s courts and prosecutors to fight against internal corruption achieved some results. Massive education and rectification programs were launched recently among judicial and prosecuting officials, in response to suggestions and criticisms the nation’s legislators made regarding work by courts and prosecutors. A total of 28 leading officials at local courts were punished last year, with three of them prosecuted. The Supreme People’s Prosecutorate (SPP) inspected and examined all prosecuting and anti-corruption officials at prefecture and county levels in 1998 as part of a reshuffling program, which aims to reinforce procuratorial and anticorruption forces. Statistics show that China’s courts dealt with a total of 2512 law-breaking or discipline-breaching judges and court officials in 1998, with 221 of them prosecuted. And another 4221 unqualified officials were fired. Prosecutors investigated a total of 1641 prosecutors suspected of having broken laws and breached disciplines. Of the total, 116 were prosecuted and 1285 disciplined. The highest-ranking prosecutorial official investigated and penalized so far was Luo Ji, Director of the Anti-Corruption Bureau under the SPP before his removal. Luo Ji severely breached disciplines concerning the management of confiscated money and goods and was removed from office. Courts and prosecutorial bodies also opened their work to supervision by the public, sponsoring seminars and publicizing reporting phone numbers. Meanwhile, they took a series of measures to consolidate their working systems and improve internal and external supervision systems. Also, some misjudged cases and questionable cases were re-examined and the results of them rectified. Courts and prosecutors also disengaged themselves from business operations in accordance with a decision by the central authorities. It seems that the Chinese central government will continue to fight corruption to help create a cleaner climate for economic and social development. Fighting corruption is important for the future of the whole nation and the Chinese Communist Party. Efforts seem to focus on advocating honesty and self-restraint among governmental officials. Disciplinary inspection departments at all levels will supervise governmental institutions to ensure a ban on their touring scenic spots in the name of working conferences, or touring abroad using public funds. Random levies will be hit hard to reduce farmers’ and enterprises’ financial burdens. More efforts will be made to better manage marketing of medicines to avoid possible

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unfair trading in medical products. Stronger steps are expected to be taken to enforce the ban on army, armed police, and political and law institutions from entering business. The central government, with President Jiang Zemin at the core, seems to regard fighting graft and building honest and clean governments as a significant task. The central government decided in 1993 to intensify its anti-corruption efforts. Since then, it has conducted studies and worked out specific schemes each year to implement the anti-corruption fight. Authorities have conducted special inspections over the years to stop governmental officials from using luxurious cars, installing modern communication equipment or dining and touring using public funds.

Types and Reasons There are about 14 types of activities that are considered corruption in China. They are (1) taking bribes or embezzling state funds and properties; (2) seeking benefits for dependents, relatives, and friends in school admission, job assignment, cadre status, exit permit, and admission to the party; (3) providing trusted followers with key official positions and later benefiting from such an arrangement; (4) retaliating and framing cases against others in search of self-benefit; (5) using public funds for banquets and gift-giving; (6) using public position and power to assist own businesses; (7) taking advantage of one’s position to occupy or build houses (from public funds) for himself or his family; (8) lavish lifestyle funded by state capital or graft; (9) forming cliques to pursue selfish interests; (10) gambling or visiting prostitutes using public funds; (11) spending extravagantly from public funds on weddings or funeral arrangements; (12) collecting bribes ostensibly as contributions for weddings or funerals; (13) smuggling; (14) kickbacks; and (15) collecting graft under the name of various “services” or “consultations.” From the social development point of view, when a society experiences social change, regulations of public office will change and laws regarding official behavior will multiply. Accordingly, some groups are disadvantaged by new laws and have to seek alternative channels for benefits. These norm changes and the legal multiplication of laws are, after all, consequences

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of modernization. As long as those societies, characterized as gift-giving, resource-scarce, and economically underdeveloped, seek modernization, they have to accept corruption as a by-product of political and economic development. Corruption nevertheless withers away as their political systems mature. For these scholars, corruption is, on balance, beneficial, because it “greases” an otherwise inefficient bureaucracy, promotes the economy by allocating resources away from consumption and into investment, helps political development by increasing political participation, and offers an alternative to violence. Although the sociopolitical and economic development process is certainly not the only determinant of corruption (corruption has proven to be a universal phenomenon), structural transformation inevitably provides more loopholes for corruption. Since many emerging problems including corruption were not fully expected in the equation of structural reform, institutional and legal systems often lag behind in redressing these problems. When the gradualist approach was used during reform, both the “market” and the culture of corruption grew. Since political reform was delinked with economic reform, bureaucrats have more windows of opportunities to exchange power for private payoff. From an economic point of view, all politicians and government officials are constrained self-maximizers. They therefore establish or maintain regulations and controls with the intent to facilitate corruption, which then becomes a source of income for them. This is not to say that non-pecuniary motivations such as working for society are never in the mind of a politician or an official. But institutional constraints that encourage truly sincere intent are rare, and even when they do operate, enthusiasm for a better society declines so rapidly in marginal value that it holds only for the very short run. In private enterprise, where resources are transferable and movable, competition limits the ability to corrupt. However, in state enterprises, limiting corruption through competition is difficult. Corruption can help offset the inefficiencies of a communist or hierarchical system, as the economy makes a transition toward private property. However, the danger is that corruption will become institutionalized and develop well-defined, transferable rights, as it has in India. Today, China is trying to shift from a system of ranking rights according to hierarchy into a system of ranking rights according to private property. In this process, surpassing the corruption hurdle in a

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quick and inexpensive manner is critical to the ultimate success of reform. To fulfill this objective, once again, is tough when gradualism remains in the process of economic and political reforms. Gradualism has a doubleedged effect on social welfare. It escalates social stability on the one hand and allows corruption phenomenon to flourish. From the Marxist–Leninist point of view, corruption is a capitalist disease. Capitalist bureaucracies represent exploitation, alienation, and parasitism. The bureaucracy does not represent a general or universal interest but rather the interest of a dominant class. The bureaucracy, first of all, is exploitative, for it controls public resources in the manner of a private owner and uses them for its own purpose. Hierarchy, the central organizing principle of the bureaucracy, is not protection against power abuse, but a source of it. The bureaucracy is also alienational, felt by citizens to be distant, beyond control. Its relationship with the outside world is not cooperative but manipulative. Finally, the bureaucracy is corrupt and parasitic. Thus, the social origins of senior bureaucrats are usually those of the ruling class, and many personal ties of influence, status, and experience exist to link members of the ruling class with members of the state apparatus, especially the bureaucracy. The bureaucracy is parasitic because it lives on the capital which comes into the world, as Marx describes it, dripping from head to foot, from every pore, with blood and dirt. The foregoing analysis of the characteristics of the modern bureaucracy logically led Marx and Engels to the conclusion that bureaucracy would not be needed after the proletarian revolution and there would be, therefore, no bureaucratic corruption under a communist system. However, the evolutionary practice of communist states has proven to be at odds with the Marxist–Leninist explanation of corruption as mentioned above. Instead of disappearing, bribery, embezzlement, extortion, backdoor relationships, and favoritism continue to exist after the communist takeover. The privilege of using, enjoying, and disposing of collectivized property through the organizational medium of state administrative institutions, has proven quite common in socialist states. Although it may not be the predominant factor, capitalist “disease” indeed propels pervasive corruption in China. This can be seen from the fact that corruption has been widely dispersed since 1979 (especially mid-1980s) when China injected capitalism in the economic reform and opened to more Western cultural influence in

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various aspects of social life. Such pervasive corruption activities arose when the communism ideology and socialism regime were eroded. From the cultural point of view, corruption has a long history in the Chinese society. After suffering social chaos from dynasty to dynasty and from generation to generation, the ruling classes and imperial government gradually became untrustworthy. Accordingly, bureaucrats, business people, and common people relied more on their own sociopolitical networks to get things done. Legal codes and disciplines sometimes yielded to political rank and power. For this reason, China has a longer history of “ruling by people” than of “ruling by law.” Despite the difference between guanxi and corruption as we discussed above, the history and culture of guanxi certainly exert a strong influence on the cultural root of corruption. Guanxi provides a possible immunity for corruptors from severe punishment of their criminal fraud. Because of the transferability and interlocking nature of guanxi matrices, it is not difficult to find and bribe someone in charge in either judiciary and prosecutorial department. Guanxiwang (guanxi network) and cellularism nexus produce corruption as a by-product and help open up a totalitarian structure. This structure often precludes systems of accountability. In practice, there are few effective legal mechanisms and balances to restrain the authoritarian power of the leadership. To some degree, this pattern may occur in many types of organizations — characterized by strong central control including hierarchical management structures and top–down decisionmaking processes. Therefore, if guanxi is the product of a long history of chaos, then corruption is mediated by guanxi. From the political point of view, the political structure in China indirectly elevates corruption as well. China has the largest pool of bureaucrats at various levels in the world, thus creating a heavy burden on the fiscal budget for the central government every year. As a result, the average level of salary for all bureaucrats at various levels has been low for decades. This low salary system did not become a major factor driving up bureaucratic corruption before mid-1980s when workload pay for people in other sectors was even lower than that for government officials. Just a few years after Deng Xiaoping called for “letting a few people be rich first” in late 1979, however, most bureaucrats quickly became one of the poorest group of people in the society. This change made many officials feel that they had lost

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social status and were treated inequitably. Understandably, many of them started to demand kickbacks, accept bribery, engage in graft, and embezzle state funds. Because institutional and judiciary systems did not correct this cross-sectorial corruption activity, the 1980s became the most corrupted period since 1949, touching off the Tiananmen Square Incident in June 1989. Although the Chinese government has made admirable efforts to rectify this problem (e.g., harsher punishments of corrupt bureaucrats, thousands of “letter and visit” investigation offices across the nation, a strengthened role of disciplinary investigation departments, among others), bureaucratic corruption is still evident everywhere in China today. It seems that the most recent effort initiated by Premier Zhu Rongqi to downsize governments at all levels (from top to bottom) while increasing official salaries is a step in the right direction to crack down on corruption. Income inequity certainly cannot fully explain bureaucratic corruption from the political perspective. Multiparty political system does not seem to be a necessary condition for eliminating corruption. For instance, we see a much cleaner government in Singapore than in Taiwan. We also see that the opportunities for bribe-collecting multiplied when India devolved power from central to regional governments. However, the establishment and enforcement of various impartial, stern, and strict laws and disciplines are indispensable. As political reform has been separated from economic reform in China since 1979, less attention has been paid to the enactment of anti-corruption laws and rules. More importantly, a few laws in this area have rarely been fully implemented and enforced. In Chinese politics, when one has been in power for years, he or she usually builds up a web-like political network within which people in power protect each other. Such webs often include people in the judiciary and prosecutorial organs. While China has weak legal, judiciary, and disciplinary mechanisms against corruption, it has an even weaker enforcement system to implement them. Hong Kong and Singapore, both city states which had fairly authoritarian governments when they launched their anti-corruption drives, have successfully fulfilled the goal of corruption crackdown. Countries which have made graft the exception rather than the rule in the conduct of public affairs — as Britain and the United States did in the 19th and early 20th centuries — have been helped by the possession of institutions such as an independent judiciary,

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a free press, a well-paid civil service and, not least, an economy in which firms have to compete for customers and capital. China may be able to draw some lessons from these examples.

7.3 MORAL DEGRADATION Unequivocally, many transitional economies are making remarkable economic progress that is attributable to their market-oriented reforms, heightened competition in deregulated sectors, and successful utilization of foreign direct investment (FDI). As a parallel to this impressive economic progress, however, transitional economies display rampant moral degradation or demoralization — the process of society’s progressive loss of or weakening of the moral and ethical structures that have traditionally prevailed. Such demoralization is exemplified by widespread sales of counterfeit products and unsafe goods, unrestrained wasting of resources, stock market manipulation, tax evasion, fraudulent dealings, ubiquitous corruption, all manner of plundering of state assets, the denial of shareholders’ rights, and so forth. In transitional economies, moral degradation can complicate firms’ engagement in ethical and social conduct. Maintaining ethical codes and social responsibility is more challenging because of the complicated moral conflicts and idiosyncratic norm standards. Moral degradation involves a society’s progressive loss of or weakening of the moral and ethical standards that prevailed in the social traditions. It is different from ‘‘moral panic,’’ which reflects the fear of a threat to the prevailing social or cultural values. In a society suffering from moral degradation, people tend to tolerate, accept, and even normalize immoral behaviors and perceptions. Degraded morality, or a state of normlessness, provides fertile soil for the growth of demoralized market arrangements. Perceived pressure in a morally corrupt local environment produces anomic strain and increases illicit activities such as bribery. Moral degradation, along with extremely high levels of social injustice and disparity in wealth derived from the unjust social conditions, create a society that is essentially socially ill and ethically apathetic.

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Moral degradation leads to institutional anomie. Institutions comprise formal elements, such as political and economic rules, and informal elements, such as social norms and conventions. Accordingly, this degradation not only weakens the power of the formal institutions but also distorts the informal institutional ideology. First, moral degradation is a condition of normlessness and social disequilibrium whereby the rules governing conduct have lost their force. In Russia, for example, after its radical ‘‘shock therapy,’’ rampant corruption and organized crime have impaired the government’s function and obstructed legitimate business activities. Pressure to achieve economic goals by any means — legitimate or not — displaces the normative control mechanisms. Firms that are consistently involved in misconduct tend to be less concerned about the impact of ethical or responsible social behaviors on the public wellbeing, and on their own development in the long run. These malfeasant behaviors are not only opportunistic, but in many cases are also illegal and criminal. The calculating, utilitarian logic of the marketplace penetrates the institutional realm and ultimately weakens the formal institutional power. Second, moral degradation also distorts a society’s social norms and ethical conventions. This degradation permeating a society may trigger a much more enduring and extensive influence on informal social institutions. Informal institutional changes associated with modernization weaken the traditional norms and increase cultural deviance and demoralization. The traditional cultural values that shape business behaviors are changing or, more specifically, are deteriorating. The traditional Chinese Confucian ethics proposes moral rules such as ‘‘righteousness’’ and ‘‘sincerity’’, emphasizes commercial ethics that forbade the sale of poor quality products and cheating in transactions, provides a strict administrative system to regulate prices, quality, and standards, and recommends punishment for those who violated the regulations. When a social system lacks appropriate commercial ethics or moral values, it incubates a propensity for firms to use anomalous means to achieve their desired ends without guilt. As economic dominance has already become the prevalent social value and institutional form, economic achievements are assigned the highest priority so that when conflicts occur, noneconomic goals give way to economic ones. Further, as personal relations and corruption are often

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intimately interlinked, regulation enforcement is arbitrary and corrupt. This intertwinement increases the permeation of massive corporate misconduct. Even if they are caught violating the economic rules, these unethical and opportunistic firms are not fearful, expecting to use their corrupt connections to halt a governmentally instituted investigation or to avoid the material penalty imposed by judiciary authorities. Hence, in transitional economies, the formal and informal institutional anomie caused by moral deterioration offers a fresh context for investigating the impact of ethical and social initiatives on firm performance. Societal degradation could significantly increase the transaction costs, operational uncertainties, and managerial difficulties related to the planning, organization, and implementation of legitimate business activities. According to institutional theory, firms would be expected to respond to external institutions, including social norms, in a similar or convergent manner. In my view, such misconduct can neither help firms to maintain their long-term legitimacy, nor can it aid them in obtaining a sustainable competitive advantage. To firms, their engagement in ethical initiatives in morally degraded environments is a strategic, voluntary choice. That is, firms have their own strategic intents and considerations in such an environment. Firms exhibiting higher levels of corporate social responsibility and business ethics will be perceived by the society even more positively when societal moral degradation increases. In other words, strategically and socially conscious firms see value-generating opportunities in a morally degraded environment by displaying increased, rather than decreased, corporate social responsibility and business ethics to showcase their unique care for, and contribution to, society. These firms understand that organizational legitimacy and related returns improve not by blindly mimicking popular but problematic social norms such as moral degradation, but by realizing and benefiting from stronger, not weaker, contributions of corporate social responsibility and business ethics to firm performance. I would view that corporate social responsibility and business ethics can become more, not less, valuable (thus contributing further to firm performance) when the moral norms in the society are more severely degraded, because the society will attach greater value to firms that are trustworthy and socially conscious.

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7.4 INTERTWINEABILITY BETWEEN GUANXI AND CORRUPTION It is my observation that parallel to impressive economic progress we see from the surface of China is the whole nation’s rampant demoralization — ubiquitous corruption, widespread fake products, shameless waste of resources, immodest power abuse, inundated crimes, immoral “entertaining” practices in business, to name a few — which, together with shockingly high social injustice and its derived wealth disparity, has made the society virtually ill and ethically apathetic. Societal demoralization and ethical paralysis could significantly increase transaction costs, operational uncertainties, and managerial difficulties in planning, organizing, and implementing legitimate business activities, to say the least. In such a demoralized society, it is my long-held belief that guanxi and corruption are becoming extremely intertwined. This intertwineability — the extent to which the content, boundary, methods, and consequences of guanxi and corruption are overlapped or duplicated — may change the public perception of guanxi: from a long traditionally-embedded culture to a rent-seeking practice involving corruption. While it remains to be empirically verified, it seems logical to predict that (1) as demoralization increases over time in a given country, the intertwineability between guanxi and corruption will increase (longitudinal dimension); and (2) in a more demoralized setting (country, region, or sector), the intertwineability between guanxi and corruption will be higher (cross-setting dimension). Accordingly, as China is becoming increasingly demoralized, the negative perception of guanxi will be heightened. In this environment, it becomes more difficult to define separately and distinguish explicitly between guanxi and corruption. Although guanxi is not necessarily an origin or a source of corrupt behavior, it is a critical facilitator of corruption in a demoralized society. In a demoralized context, the general rule of guanxi is shifted toward power exchange and gain sharing without obligating formal laws and informal relational norms. Interestingly, guanxi itself works as an important power base that represents saved favors, faces, and special relationships with powerful people. When relational norms and Confucian values are considerably eroded,

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guanxi could bring out further egoism, opportunism, and instrumentality. When ethical awareness disappeared and relational norms are ignored, guanxi will be permeated by instrumentality, self-seeking opportunism, and dishonorability rather than by trust relationships based on mutual warmth, loyalty, and respect. The degeneration of a system of moral norms, which are either substituted by lower moral standards or not replaced at all, represents a state of anomie or normlessness and social alienation. Individuals lose the motivation to contribute to collective goals or to act ethically. In this circumstance, guanxi and corruption are more intertwined, both propelling dishonorability, a danger to social and economic development. In a demoralized society, the above intertwineability will inevitably result in corrupted guanxi and guanxi-based corruption, the conjoined twins that cannot be separated. In some extreme cases, there may be no business guanxi network that is not tinted by corruption and no corruption without using guanxi. In the 1970s and 1980s, guanxi largely meant to obtain scarce consumer goods or to find a better job for one’s children through the “back door.” Today, guanxi is implicated in almost all big corruption cases. One particular feature is that corruption has evolved from individual wrongdoings into institutionalized corruptions that often involve a complicated guanxi network between high-ranking officials and private businessmen. Indeed, corruption exists in every country or society, but it is guanxi that provides a fertile soil in China for corruption to flourish when the country is largely demoralized. Even worse is the fact that, in such a demoralized environment, some legitimate businesses may face increasing pressures to engage in corruption or other illicit activities as well. Often, they may be forced to develop corrupted guanxi and conduct guanxi-based corruption to get the thing done. It is reported that guanxi becomes a powerful tool wielded by corrupt officials to blackmail business for their personal gains. It is worth noting that the above intertwineability varies according to different layers or types of guanxi. For jia-ren, which designates the closest possible relation, namely of family members — traditional social norms that are deeply rooted in Confucius philosophies (e.g., family obligations) will largely remain. In this case, the intertwineability between guanxi and  corruption is expected to be weak. However, this intertwineability

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may be increased for shou-ren guanxi — a web of relatives (kin and clan) and friends. Traditionally, China has been typified by its kinship and worldly society where social bonds are based on genealogical or cliquish relations. In such a clan or cohort, people are connected by consanguinity or friendship and thus are mutually attached and committed. Among other things, mianzi and renqing, as explained in Chapter 1, work as two major mechanisms by which people develop, maintain, and extend guanxi with others. For shou-ren, reciprocity is the central role to maintain one’s social reputation or face value. As the society becomes increasingly demoralized, however, I expect that the importance of mianzi, renqing, and reciprocity is diminishing at the same time. In a demoralized society, these social norms or rules will be less respected and honored. As a result, violation of these norms will almost surely rise. As demoralization goes up, favor-seeking will be progressively shifted to rent-seeking (focusing on private or economic gains) in shou-ren based guanxi. The above intertwineability is even higher in sheng-ren guanxi. A web of guanxi implies a limited space or amount of favor that people can draw upon to maintain their trust in and commitment to such an interpersonal relationship. Inclusive of those, such as residents of a local community, fellow employees in the same large company, customers of a business, and especially, foreign business people, who are outside of the family unit or shou-ren web, people will assume utilitarian stances, focusing on personal gains and losses. Because interactions with sheng-ren are superficial and temporary, instrumentality or opportunism will work as the rule of guanxi in this instance. In a demoralized society, rent-seeking behavior in shengren guanxi is particularly easy to transmit to corruption. For instance, bureaucratic corruption is essentially a rent-seeking behavior capitalizing on the monopoly power and common people’s favor-seeking behavior. In this game, guanxi plays a vital role in connecting rent-seekers to favorseekers. Guanxi works not only as the shortcut around bureaucratic power but also as the mechanism that allocates rent in a black or gray economy, in which rent is usually reaped in an unofficial way. As demoralization is permeated, loosely defined relational norms are significantly weakened while opportunistic behaviors without the sense of guilty will dominate in the society.

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7.5 ECONOMICS OF CORRUPTION The institutional distinction of bureaucracy from market situation makes a simplistic application of the market or economic model insufficient to disclose the genesis of bureaucratic corruption. However, the economic view of corruption provides some analytical insight into the question. At the macro level, a partial equilibrium view of economics holds that corruption generally is good, though sometimes not so good. It is good because most regulations and controls move the market away from Pareto optimality. Corruption will then cause a move back toward the Pareto optimum. Some regulations, however, are good because they move the economy closer to Pareto optimality. Therefore, some corruption is good and some is bad. With bad regulations, corruption is good. With good regulations, corruption is bad. This partial equilibrium view is recently criticized as being too “theoretical,” overconcerned with Pareto optimality, and overestimating the rationality of the corruptor. Development economics suggests, for instance, that corruption is deadlier. It ravages each and every stratum of life, political, social, and economic. Corruption is interstitial and robs the nation of precious resources which are plundered for private gains, impoverished large masses and ruins chances of orderly development. Monumental corruption destroys human values. It is not the grease that oils the economy, but the slippery road to cronyism and lost opportunities. Graft and bribery gives officials an incentive to create red tape; and corrupt officials, like blackmailers, raise the price of releasing their victims. Corruption acts as added tax on FDI and misdirects resources on a catastrophic scale. A flurry of recent studies has shown that corruption, as measured by indices published by corruption-fighting groups like Transparency International, is closely connected to economic malpractice. A pioneering 1995 paper by Paolo Mauro, an economist at the International Monetary Fund (IMF), showed that countries with a lot of corruption have less of their GDP going into investment and lower growth rates. His later work has suggested that corrupt countries invest less in education than clean countries do. The World Bank in 1997 suggested that where corruption is predictable, i.e., where the briber knows what he has to pay and can be sure of getting what he pays for, it harms investment less than where it is capricious.

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Even so, they found that no matter how high the degree of predictability of corruption in a country, its rate of investment was significantly lower than if there were less corruption. Rose-Ackerman (1975) examined the relationship between market structure and the incidence of corrupt dealings in the government contrasting process. She found that the amount of corruption is not merely a function of the amount of resources devoted to surveillance and law enforcement. More fundamental factors are at work: if the market structure changes from a form especially conducive to dishonesty to another in which the incentives for bribery are more limited or non-existent, preexisting corrupt relationships are likely to be uncovered. Her study also showed that when the government purchases a good also sold in the private market, the incentives for bribery are substantially less than those obtained when the government is the sole purchaser. This implies that when policymakers recognize that there can be hidden corruption costs involved in ordering goods especially for state use, it may often appear that the purchase of standard items sold on private markets will be justified despite some quality loss. Another policy implication from this study is that when goods must be ordered especially for government use, policies should be designed to reduce vagueness in purchasing instructions given to officials, thereby reducing the costs of effective surveillance and increasing the probability of detection of serious speculation. This result further implies that an effective law must do more than impose heavy penalties upon the participants of the illicit bargain; so far as firms are concerned, even a heavy fine whose amount is a function of the bribe paid may fail to deter corrupt activity. To sum up, macroeconomic views tend to have a gradually more negative attitude toward corruption, particularly toward welfare effects of corruption, over time. Traditional economic analysis maintained that bribes constituted transfer between economic actors and have, therefore, only redistributive effects. Others argued that corruption could lead to improved economic outcomes, basically because bribes might serve as piece rates to motivate badly paid bureaucrats, and because it might be a way to avoid cumbersome regulations. Later, some economists suggested that corruption distorted incentives and provided a reward for introducing further regulations so that it is detrimental to growth and investment. Recently, several studies suggest

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that the costs of corruption may be grossly underestimated. Acting as a tax on profits, graft induces exit of firms, causing the loss of consumer surplus associated with the consumption of each product lost on account of exit. At the micro level, economists believe that individuals engage in illicit economic activities based on carefully weighed cost-benefit considerations. The economic approach views corruption within a model of rational individual choice based on the assumption that corruption is part of a rational calculus and an integral and often deeply rooted method by which rational individuals seek to promote their own interests in a competitive market. It occurs because of two factors: a monopolistic condition on the side of the bureaucracy and a black market to benefit profiteering activities of the bureaucracy. A modern bureaucracy is like a mandatory model of market economies: it is expected to fix price schedules based on costs and benefits of both sellers and buyers. In reality, however, supply and demand always go out of balance. When demand outpaces supply, a black market in government services may surface. James Scott (1969) further distinguishes between “parochial” corruption and “market” corruption. The former refers to the favors given by public officials based on ties of kinship, affection, caste, and so on, while the latter is based on the criterion of who pays the most, no matter who they are. Corruption also affects the number of firms in a free-entry equilibrium. The degree of deep competition in the economy increases with lower overhead costs relative to profits and with a tendency toward similar cost structures. The conventional wisdom in microeconomics thus suggests that increasing competition may be a way to reduce the returns from corrupt activities. The presumption is that no bribes can occur in markets in which perfect competition prevails, when there are no excess profits from which to pay the bribes. The neoclassical view in microeconomics, however, asserts that the above argument may be oversimplified. Indeed, practical experience seems to show that countries that have increased levels of competition in the economy have sometimes experienced upsurges in corruption. Corruption may be used to counterbalance competitive pressure in order for a firm to survive in the market. Competition is not necessarily an exogenous parameter that one can vary in a model to see how corruption is affected. Corruption may itself affect the extent of competition. It is clearly deficient to take the number

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of firms as an indicator of the level of competition in the market. Both the equilibrium number of firms and the level of graft are more likely to be endogenously determined by other parameters such as institutionally created opportunities for corruption and competitive pressure rather than by the number of producers. In conclusion, increases in competition may not lead to lower levels of corruption. A free-entry equilibrium in which firms have overhead costs does not possess the optimality property of a competitive equilibrium. The key assumption made by classical microeconomics is that firms in the same market share the same cost structure under high competition. Thus, competition can kill corruption because of cost pressure. According to this view, there will be no surpluses when there is perfect competition. The neoclassical view holds, however, there is no implication that all firms have the same costs if we allow individual firm production functions to not exhibit constant returns to scale. It could be a mistake to look for preexisting surpluses to model corruption in general equilibrium. Corrupt payments become built into the cost structure. In this case, corruption does not need any preexisting rent or imperfect competition, since the prospective excess profits from which to pay bribes may be created by inducing exit. Thus, differences in the cost structure of different competitors create surpluses that an corrupt individual official can milk. This gives a motivation to all officials to demand bribes. This will drive the most inefficient firms out of business, enhancing the profitability of other firms, in turn making it possible for corrupt bureaucrats to demand larger bribes. This does not lead to the eventual extinction of all firms, because when the flow of payments from firms to officials reaches a high level, the officials are no longer willing to risk losing the source of their bribe income. From the transaction-cost point of view, corruption can be perceived as an economic transaction. Oldenburg (1987, p. 512) defines it as “the exchange of money or favor for a benefit disbursed by a government official.” This definition is succinct but limits the problem to purely public situations. It also fails sufficiently to delimit the nature of the benefit disbursed by the government official. The phenomenon is, however, closely related to private situations such as commercial bribery which Coase (1979, p. 307), quoting the New York Penal Law, defines as occurring when a person “confers, or agrees to confer, any benefit upon any employee, agent or fiduciary without

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the consent of the latter’s employer or principal, with intent to influence his conduct in relation to his employer’s or principal’s affairs.” Yet corruption of both types has been of concern to business people operating in Third World Countries. Thus, Macrae’s (1982, p. 678) defines corruption as “an arrangement is a private exchange between two parties (‘the demander’ and the ‘supplier’) which: (1) has an influence on the allocation of resources either immediately or in the future, and (2) involves the use or abuse of public or collective responsibility for private ends.” This definition seems more useful as it includes the use or abuse of collective responsibility which can include that of any organization — private or public. According to Williamson (1985, p. 1), a transaction “occurs when a good or service is transferred across a technologically separable interface.” Corruption can be conceived of as the transferal of a service between the bribe donor and the bribe recipient. Two basic types of services can be provided: “according-to-rule” transactions and “against-the-rule” transactions (Oldenburg, 1987). In the former, someone is compensated extralegally to do what he or she is ordinarily required to do by law. Such “grease” payments are often made to assure that permits are processed in a timely manner. In the “against-the-rule” transitions, the bribe is paid to obtain the cooperation of someone to do something they are forbidden to do. An example would be money paid to award a contract to a company which would not otherwise have been awarded the contract. But can “grease” payments, which cause the official to expedite some procedure he or she would have done anyway, properly be considered a transfer of some service across a technologically separable interface? It seems that the concept of transaction can still be applied to such payments. The service, however, is not the actual processing of the permit that was desired. Rather, it consists in the change in the time frame within which occurs the desired action. This sense is still consistent with Williamson’s transaction. The concept of rationality plays an important role is transaction-cost theory. Economic theory typically assumes that actors are rational. Rationality includes the notion that actors have preferences which they can order and that they choose so as to maximize their satisfaction in the consumption of goods. Transaction-cost economics, on the other hand, holds that actors’ rationality is limited. There are limitations on the ability of actors to process

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and evaluate information. These limits help explain why certain institutions arise. Without these limitations, it would be possible for the parties to plan all possible contingencies in advance and thus reduce the uncertainty of the exchange. This rationality logic applies in corruption transactions. As one faces large bureaucratic structures in many third world countries, for instance, it often becomes difficult to know “who, precisely, will take the bribe” (Oldenburg, 1987, p. 529). Comprehensive, ex ante planning is thus not feasible. The second behavioral assumption of transaction-cost economics is that actors are opportunistic. Williamson (1985, p. 47) defines opportunism as “self-interest seeking with guile.” This refers to the “incomplete or distorted disclosure of information, especially calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse.” Because of opportunism, the parties are forced to rely on contractual safeguard, rather than on simple promise-keeping. Since corruption transactions occur outside the law, there are many opportunities for the parties to take advantage of each other. Numerous situations allow for the systematic distortion of information in order to benefit a particular party in a corruption transaction. The value of the transaction to the bribe recipient can increase due to manipulation of information and thus create a continual incentive which makes truth-telling and promise-keeping difficult. Finally, asset specificity refers to the difficulty of redeploying assets to their next best alternative use without a significant sacrifice in value. Williamson (1985) distinguishes among three degrees of asset specificity. Nonspecific assets such as ordinary office supplies and caustic soda, are easily redeployed to other uses. Idiosyncratic assets, on the other hand, are specific to a situation and cannot be redeployed. A typical example is that of an electric-generating plant built at the mouth of a coal mine. It is next to impossible for the electric plant to switch its coal supplier without greatloss in value. Another example is the firm-specific, human capital which an employee may develop in working for a single company a long time. Such knowledge of the politics and procedures of a particular company, invaluable within that company, are almost worthless with respect to other companies. Mixed assets stand in an intermediate position between these two extremes. Such transactions may involve the purchase of customized

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material or equipment which is capable of alternative uses, although at some loss in value to the owner (Williamson, 1985, p. 73). For example, customized material or equipment can often be switched to other uses, but only at some loss in value. When assets refer to human-capital investments, the notion of asset specificity is certainly applicable to corruptions which are transacted with such bureaucrats or others that have specific powers for specific activities. Most corruption transactions are tacit, organizationally or individually embedded, and difficult to copy. Corruption transactions also have significant idiosyncratic attributes which have important organizational consequences. Such idiosyncratic attributes include the complexity of the transaction as well as the social relations which exist with key people in an organization which is the object of a bribe. A distinction is often made in the corruption literature between price or market corruption and parochial corruption. Scott (1972, p. 89) explains this difference as follows: It is precisely in those areas of government activity involving a large number of small transactions — the issuance of drivers’ licenses and permits for village market stalls, the settlement of minor criminal charges, the acquisition of seats or freight space on railway cars, to mention but a few — that “price” corruption is common. Over time, it is also in these areas that market corruption tends to become institutionalized so that there is a widely known and rather stable price for a particular action. By contrast, the market in large transactions involving such benefits as import permits or large construction contracts is likely to show less price stability and greater intrusion of parochial considerations.

Market corruption is well illustrated in Monterrey, Mexico, where a multitude of “coyotes” await outside the department of motor vehicles to expedite the processing of a driver’s license. The market rate for such a service in easily ascertained by any anonymous applicant who can easily compare prices among a number of different coyotes. The greater intrusion of parochial considerations, on the other hand, refers to the idiosyncratic aspects of the transaction. At this point, the

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tacit dimension or personal knowledge of which Polanyi (1962) speaks describes best the kinds of highly nuanced knowledge and relations needed in order to carry out such transactions. Often transactions require the careful orchestration of the activities of a large number of people which change according to the nature of the favor sought. In addition, over time, repeated transactions can lead to trust relations developing between the donor and the recipient (Bunker and Cohen, 1983). The point is that these transactions often involve investments in human capital with little salvage value outside the particular transaction or relationship. Thus, we can see that the concept of asset specificity applies whether the transaction involves the purchase or sale of equipment or of an illicit favor.

7.6 BUSINESS IMPLICATIONS OF CORRUPTION Like guanxi, corruption owns both benefits and costs. Unlike guanxi, however, benefits of corruption are deemed to be much less than costs incurred for a corrupt activity. Since guanxi is essentially favor-based, socially binding, long-standing, and reciprocally obligated, guanxi creates long-term synergies or net economic rent for all parties involved. In contrast, corruption involves high costs and great uncertainties about payoffs. Although it is possible that returns from corruption may outweigh costs incurred for a specific deal or business in the short term, it is unlikely, if not impossible, that a firm can build on corruption to achieve a sustainable competitive advantage and abnormal profitability in the long run. As detailed below, this book argues that corruption represents a firm’s evolutionary hazard, strategic impediment, competitive disadvantage, and organizational deficiency in the long run. Our following discussion is framed in an assumption that firms attempt to achieve their business goals using bribery with corrupted bureaucrats.

Corruption as an Evolutionary Hazard As an evolutionary hazard in the long term, corruption obstructs firm growth and business development through four interrelated channels, namely risk effect, punishment effect, image effect, and cost effect. First, all corrupt

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activities are highly risky for all actors because of the illicit nature. Such activities are always based on oral agreements that are covert, hidden, and nontransparent. The degree of risks is a function of a bureaucratic corruptor’s willingness, power, position, experience, and network. As many corrupt activities are each associated with many people, including officials, businessmen, and others who may not even know each other, a discovery of a criminal fraud in any stage in the corrupt process or any person in the corrupt web could quickly impose high risks to everyone else linked to the network. When a firm uses bribery to achieve its business goals, an entire organization will be involved with this risky and unpredictable process. Any person, whether top or middle management, can risk the whole company reputation if he or she is found to use bribery for organizational purposes. Second, when a criminal fraud of corruption for organizational purpose is found, both the individual and the organization will be severely punished legally, institutionally, and disciplinarily. During the anti-corruption campaign, judiciary punishment was particularly harsh, including criminal sanctions as well as economic fines. Institutional punishment includes reorganizing an entire firm led by the upper level government authority, removing top managers involved in bribery, and rectifying a series of operational and financial policies. Generally, it will take several years for a company to restore normal business after this reorganization by the government. The firm has to rebuild its business connections and reputation. This, however, takes time, probably years. Institutional punishment may also include the cancellation of institutional membership in industrial associations, elimination of preferential policies previously provided by the government, and placement of more communist party leaders in top management. Although disciplinary punishment is relatively parochial and affects only those directly involved middle managers as well as those indirectly engaged senior managers, its impact on business operations may be crucial. Disciplinary punishment against those important managers of a firm by the Communist Party’s disciplinary departments or other governmental authorities demotes or freezes their business posts and terminates their political career. This substantially deters their further commitment to the firm. When they quit their jobs, which happens frequently in China after punishment, most of their customers and networks are gone with them.

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Third, the image effect mainly lies in the stereotype loss that can either increase costs or reduce the income stream for the company. Most Chinese consumers purchase products according to the stereotype or image of a company. When a company’s engagement of corruption and bribery is publicized, consumers will quickly have a stereotype that this company is poorly managed, produces defective products, and cannot ensure customer service. Once a company is perceived with this stereotype by the market, it will be difficult for it to survive and grow. Several studies have found that organizational reputation is positively associated with both market and financial performance (e.g., Luo, 1997). Chinese consumers value this reputation highly since they have suffered from badly made fake products. Indeed, the corruption-performance relationship is often a vicious cycle: corruption hurts firm performance; ill-performing firms tend to use more bribery as the prescription to cure their illness; and more bribery further increases costs and plagues reputation, thereby deteriorating performance. Lastly, all bribery transactions inevitably involve financial costs. Corporate bribery itself is a monetary investment aimed at organizational payoffs through suborning bureaucratic power, which is otherwise not legally achievable. Unlike guanxi, which essentially builds on favor exchanges, bribery is a fully monetary transaction between power and illegal private gains. Although the price of these transactions varies among different deals depending upon the clearing equilibrium between “demand” and “supply,” the marginal revenue of bribery is generally low due to a high level of visible costs and invisible risks as mentioned above. A bureaucratic corruptor will usually “charge” more (“risk premium” in the language of finance) when this risk is perceived to be higher. As a result, a company must not only pay more but also assume more risks when bribery and corruption risk, a part of political or systematic risk according to the finance literature, is high. This cost effect directly attenuates a firm’s growth potential.

Corruption as a Strategic Impediment Corruption as a strategic impediment is mainly manifested in resource misallocation and capability-building deterrence. According to the

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resource-based view of firms, resources that can generate a sustainable competitive advantage in every firm are limited. Facing this constraint, the strategy to allocate these strategic resources is essential to the firm growth and evolution. This allocation could even have a deeper impact on firm performance than resources themselves, since the former affects a firm’s dynamic capability, whereas the latter influence only a firm’s static capability (Barney, 1991). All bribery activities, no matter who their targeted bureaucrats, have to invest financial resources, human resources, and time. Financial resources may not be strategic in advanced market economies but are distinctive in China. This is because all bribery money comes from a firm’s internal funds accumulated from retained earnings. In all the countries’ accounting laws or standards, bribery expenditures cannot be recorded as production costs (direct or indirect) or operational expenses (overhead). For most Chinese firms, accumulated internal funds are very limited given the high burden of income tax, industrial and commercial consolidation tax, profit sharing with the industrial administration departments and local governments, and various miscellaneous fees of governmental agencies that have to be amortized by firms. More importantly, such internal funds are the only source for firms to further develop. Consequently, when internal funds are used for bribery, firm growth and business development are hampered and impeded. In a competitive environment, firm growth depends on its dynamic capabilities such as organizational learning, knowledge upgrading, continuous innovation, and innovative corporate culture. In bribery culture and corruption atmosphere, none of these dynamic capability mechanisms can be fostered and nourished. Instead, corruption and bribery will obstruct organizational movement in such directions. A firm relying on bribery generally perceives corruption and bribery as a substitute for innovated technological and organizational skills. It may expect that bribery is a quicker, and perhaps more effective, strategic instrument to accomplish organizational goals than building and upgrading dynamic capabilities. When top managers attach high value to bribery, firms are deemed to have greater organizational inertia and less commitment to develop new organizational capabilities. Financial constraints (limitation of internal funds) faced by most Chinese firms additionally hinder the development of dynamic capabilities.

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Corruption as a Competitive Disadvantage Corruption as a competitive disadvantage is reflected by dishonesty and untrustworthiness hurting a firm’s competitive position in the market. An exchange partner worthy of trust is one that will not exploit the other’s exchange vulnerabilities. While trust is an attribute of a relationship between exchange partners, trustworthiness is an attribute of individual exchange partners. According to the resource-based view, credibility is an important resource that creates competitive advantage and distinguishes a firm from other rivals. Corruption and bribery, however, precipitate dishonesty and dissipate credibility. When a firm is involved in corruption and bribery, other firms will perceive it as unreliable and avoid it. Dishonesty and unreliability thus destroy, rather than stimulate, business networks. The illicit nature of corruption and bribery mirrors an individual or organizational untrustworthiness. Being law-abiding is a prerequisite element for corporate reputation and trustworthiness. Because organizational trustworthiness is in large part embedded in the top managers’ credibility and honesty, corruption has an enduring impact on the firm unless these managers are removed from the organization. In an increasingly competitive environment, long-term relationships with suppliers, buyers, distributors, and other firms affecting a firm’s backward or forward value chain become fundamental. A break in such long-term relationships as a result of corruption or bribery longitudinally and fundamentally hampers a firm’s market reputation and competitive advantages. Restoring old relationships and initiating new networks may take years if an incidence of corruption or bribery occurs. Moreover, unreliability and untrustworthiness arising from corruption and bribery reduce consumer confidence in a firm’s service and erode consumer loyalty. This further inflates a firm’s competitive disadvantage in the market. In the perception of most consumers, corporate bribery or corruption implies organizational illness and operational deficiency.

Corruption as an Organizational Deficiency Corruption or bribery is often the product of mismanagement. It violates business ethics and arms-length business principles. Since top managers are

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more or less involved with corrupt activities, corruption implies problematic organizational leadership and ill business morality. Under such leadership, it is realistically impossible for a firm to have an innovative culture, efficient administration, transparent communication, effective information flow, and productive collaboration across departments or divisions within a firm. According to Weber (1971), corruption is an organizational pathology which results from impediments created by the bureaucratic structure. Its essential theme is the inability of bureaucratic organizations to accomplish public purposes because there are certain inherent characteristics in every administrative system which are detrimental to honest behavior. Bureaucratic managers have, in general, a complex set of goals. Some are manifestations of pure self-interest, while others are almost altruistic. Still others stand in the middle as mixed motives. Thus, every manager acts at least partly in his or her own self-interest, and some officials are motivated solely by their self-interest. This view accords with March and Simon’s observation (1958) that in an organization most members are motivated indirectly by organizational objectives and directly by the incentive structure. It is clear that the bureaucracy is not so pure from the very inside. So it is not surprising to find that organizational officials are motivated to create informational networks of friends, favor recipients, contracts, and communication links based upon primarily personal, rather than official relationships with others. Nor is it unusual that organizations that cannot charge money for their services must develop non-monetary costs to impose on their clients as means of rationing their outputs. Anthony Downs calls this the “Law of Non-Money Pricing” (1967, p. 188). Some scholars explicitly illustrate the linkage between bureaucratic corruption and characteristics of bureaucratic organizations. Banfield (1975) compares the main structural features of the “typical” business (a competitive organization) with those of a government organization and concludes that corruption can be readily seen as a feature of the latter. Williams (1987, p. 63) expresses the same concern: opportunities for bribery and nepotism increase as the scope and size of government expand, because of the impossibility of framing rules and regulations to meet every circumstance or contingency. Rose-Ackerman (1999, pp. 170–184) has a more refined analysis of the relationship between bureaucratic structures and corrupt

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bureaucratic behavior. By examining how alternative bureaucratic structures affect the incidence and level of corruption, she stresses the necessity for reformers to “move on to propose more particularized structures — closer monitoring, higher pay, nonvested pension, rights, and so forth — that will increase the expected costs of peculation at the critical soft spots.”

7.7 GOVERNANCE AND GUANXI Corporate Governance in China Corporate governance has been attracting a good deal of public interest because of its importance for the economic health of corporations and the welfare of society. It represents the relationship among stakeholders that is used to determine and control the strategic direction and performance of organization. Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set and the means of attaining those objectives and monitoring performance. Corporate governance requires developing internal processes and structures within a firm to minimize agency costs between shareholders, or more broadly, stakeholders and top management. Corporate governance reflects and enforces the company’s value and contributes to the firm’s legitimacy and the credibility of its decisions and reporting. Corporate governance in China is transitional. Since late 1978, China has gradually transformed itself from a centrally planned economy into a market-oriented economy. Beginning in 1990, China developed a nationwide equity market with stock exchanges located in Shanghai and Shenzhen. Although the time is not that long, the number of listed companies has increased significantly, rising from 14 in 1991 to 1223 in 2002, while the market capitalization rose to about US$500 billion in the same year, placing

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China in ninth place globally in market capitalization terms. It was not until 1999 that the term corporate governance found its way into China. Questions concerning ownership and board structure as well as accountability, transparency, and fairness are the basis for a well-functioning corporate governance system. Weak corporate governance, on the contrary, can raise the cost of capital, lower the operating performance of industry, and impede the flow of investment. Furthermore, weak corporate governance also breeds corruption. Overall, the Chinese corporate governance system is presently still full of weaknesses. The ownership structure in China’s listed companies is unique. About two-thirds of the shares are not listed and are presently not allowed to be traded in the markets. Among these non-tradable shares, state-owned accounted for 57.24 percent of total in 2000, institutional shares for 5.66 percent, and employee shares for 0.64 percent. Among tradable shares in 2000, common stock A-shares accounted for 28.50 percent of the total stocks listed, common stock B-shares accounted for 4.01 percent, and common stock H-shares accounted for 3.29 percent. Regardless of share types, shareholders’ entitlement is the same in terms of dividends and voting rights. However, the methods of exchange differ among the types of shares. The floating A-shares are freely traded on the stock exchanges while state and legal person shares cannot be traded publicly. Overall, the body of institutional investors in China is relatively small due to the absence of large block institutional shareholders such as pension funds and mutual funds. Institutional investors also do not actively participate in the governance of firms even when they possess a significant proportion of shares. Although the Chinese stock market has made significant achievements since its initiation in 1990, its function, service, transparency, and efficiency is all far from completion. One of the major problems that hampers the market function has to do with the weak corporate governance of Chinese enterprises, whether state-owned or not, listed on the exchanges. For stateowned companies, which constitute the majority of companies listed, the state, or government, usually is the dominant shareholder and hence plays a dominant role in the decision-making process of the board of directors. The chairperson of the board of directors and the CEO are often the same person who is appointed by the state to “administer” the company as a

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representative of state ownership. Therefore, it is reasonable to expect that such CEOs are more responsible in protecting the interest of the state, the biggest shareholder. On average, less than 10 percent of listed companies actually distribute cash dividends to shareholders. Therefore, minority shareholders have no other choice but to obtain capital gain from the trading spread. This is why the Chinese stock market is enveloped by a thick atmosphere of speculation through short-term trading. In the Chinese stock market, the trading turnover ratio is four to five times per year on average. The relatively high turnover ratio indicates that the total trading volume is much more than the total market value and in turn implies that investors tend to speculate more than invest for the long-term. This kind of behavior distorts the market, particularly, the market price. The Chinese stock market is also often called a “policy market,” as it is influenced by government policies much more significantly than market forces and economic factors. The phenomenon that the stock market dances so closely with the rhythms of political events reflects the significance of the government’s interference in the market. Moreover, the government intervention is more influential than the market-oriented, socioeconomic factors. Investors who have contacts in or with the government and know the news ahead of time can benefit the most from the stock market. Under such an asymmetric information flow mechanism, insider trading and price manipulation are rampant. The consequence is that Chinese investors are “government policy watchers.” Due to the dominant ownership by the state, Chinese enterprises are largely financed by state bank loans under government influence. Close links among firms, their banks, and the government have been developed through a business system of state and political deal-making. Both firms and banks within this relationship-based system feel little need to develop corporate governance mechanisms, since the former are able to rely on banks to continue to finance their projects and the latter feel comfortable under explicit or implicit government guarantee. Government agencies tend to provide subsidized credit to firms in targeted industrial sectors and implicitly share their investment risk. In this sense, subsidies act against strategic transparency as long as subsidized firms do not have to face market mechanisms and competition which both require adequate disclosure to

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outside investors. Meanwhile, outside investors have little incentive to heavily invest in a new relationship given the weak legal infrastructure that protects their rights and the resulting lack of corporate transparency. The state ownership is administered by the State Asset Supervision Administration Commission (SASAC) which has branch offices in each province and city. Thus, listed state-owned companies are essentially supervised and governed by this agency. Compounding the state dominance and interference in corporate governance is the fact that many strategic decisions, if not all, are influenced by the senior secretary of the Communist Party committee imbedded in a state-owned company. When this political “boss” in the company is the same person as the chairman of the board, he or she becomes even more powerful in intervening management decisions. When the chairman and the secretary are separated, it often creates more conflicts and collisions among executive, board, and party secretary offices, since they represent very different groups inherently concerned with different sets of interests. Executive compensation in Chinese companies is generally low. Although many enterprises have begun trying a more market-oriented approach to executive compensation since 2000, few have considered corporate governance in the design and implementation of executive compensation incentive plans. In fact, most enterprises have their executives (internal staff) formulate their own compensation. Before 2000, the annual cash compensation of executives in most state-owned companies was below US$25 000. Executive compensation in Chinese enterprises generally comprises basic salary, annual bonus, benefits (such as housing), and perks. A minority of enterprises implement long-term incentive plans, tying executive compensation to company performance. In general, listed companies today have a greater degree of autonomy than before in formulating their executive compensation and are recently moving toward market-based compensation. But still, such practices must comply the SASAC-formulated compensation policies. In general, executive directors play a dominant role in the board while non-executive directors have a limited role. China’s regulatory authorities have recently reformed the structure of executive compensation and corporate governance. The China Securities Regulatory Commission requires independent non-executive directors to make up one-third of the number of directors. Parent companies are also restricted from concurrently

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engaging in key positions of companies limited by shares. Overall, executive compensation and corporate governance in China still fall short of the compliance standards and best practices of developed countries, marked by insufficient information disclosure and a lack of transparency in the design and management of executive compensation and long-term incentives. Self-designed executive compensation and incentive plans still exist in some companies.

Guanxi and Governance Guanxi affects corporate governance in two ways. First, guanxi plays a crucial role in establishing interlocking directorate which is one corporate governance mechanism. Second, guanxi affects family-centered corporate governance structure and process. While the first role applies to governance in any general context, the second role is more relevant to privately-owned companies in China and family-owned companies in Asia, especially in those countries where ethnic Chinese play a dominant role in local economies (e.g., Hong Kong, Singapore, and Malaysia). Interlocking directorate is a widely used practice whereby two or more companies exchange board members (e.g., Company A’s chairman sits in Company B’s board). Often, these companies are strategic partners such as those in long-term supply agreements, R&D consortia, joint ventures, or alliance groups. When two or more companies are cross-shareholders, interlocking directorate is even more common. Interlocking directorate can benefit member firms in several ways: information sharing among key executives or board members, collaborating and knowledge sharing among member organizations, and obtaining assistance and support from group members when a firm struggles financially or operationally. However, from the agency cost perspective, interlocking directorate may obstruct decisionmaking independence and transparency because under-performing managers who maintain good personal ties with their interlocking partners may stay in their jobs. It may also lead to conflicts of interests since board members may be biased due to conflicting objectives of member companies. Thus, the use of interlocking directorate should be structured in such a way that decision-making independence and transparency are not lost.

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Interlocking directorate is essentially a practice of guanxi among board members at different companies. Naturally, those board members from different companies maintaining stronger guanxi are more likely to create an interlocking directorate web. Through this web, these companies are in turn more likely to collaborate in various ways in sharing existing resources or developing new capabilities. In this sense, existing guanxi is a central catalyst of interlocking directorate. When anti-trust and anticorruption laws are stringent and corporate transparency is in place, this guanxi-underpinned directorate can help the growth of member organizations because it promotes interorganizational sharing of information, knowledge, and resources. However, if these laws are weak and corporate transparency is absent, guanxi-based directorate could possibly lead to collusion and corruption. On the other hand, sustained and legitimate directorate relations may also create an opportunity to cultivate new or future guanxi. Through formal meetings and informal socialization, these board members may solidify the personal ties or become more attached. In conclusion, guanxi and interlocking directorate are mutually reinforcing. Still, it should be cautioned that control of China’s companies rests primarily in the hands of insider managers. This results in an insider system which operates without much regard of the interests of the company and shareholders. Examples of these problems include collusions between managers and employees transferring firm assets from the state-owned enterprises, tax evasion, and corruption among managers. There is no evidence yet that the board of directors and/or supervisory board have performed substantial oversight functions over the management and therefore improves corporate governance. Far from it, the board often has weak or no means of disciplining poorly performed executives. Guanxi among family members and relatives significantly influences the family-centered corporate governance, especially for some large diversified conglomerates listed on stock exchanges in Asia. For instance, 644 firms out of the 1000 largest firms in Thailand are identified as affiliated companies belonging to 212 family-owned groups and their combined sales account for over 50 percent of grand total sales of the 1000 largest firms. These figures apparently evidence the prominent presence of family businesses in large-sized Thai firms.

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The family-centered relationship model in corporate governance is even more evident in those countries or regions where ethnic Chinese play a dominant role in local economies (e.g., Hong Kong, Singapore, and Malaysia). Asia’s traditional corporate model sits uneasily with modern practice. Families are a key source of capital, contacts, and customers. That is logical enough when uncertainties and risks are high and capital markets underdeveloped. Interlocking networks of subsidiaries and sister companies can allow funds to flow quickly into promising new businesses. But such networks are opaque and discriminate against outside investors. Moreover, the ambiguous role of the state, not only as a regulator but often a shareholder in Asian companies, creates conflicts of interest and gives too much power to politicians. To illustrate the above points, ethnic Chinese family businesses in Singapore are perhaps the best example. Ethnic Chinese in Singapore have been estimated to control about 80 percent of Singapore’s listed companies by market capitalization alone. Three of Singapore’s “Big Four” banks can each trace its origins to financing trade among the Chinese community in both Singapore and the rest of the world. About half of all public-listed Chinese family firms in Singapore own controlling stakes of more than 50 percent. This implies that public-listed Chinese family firms in Singapore are still, to some extent, controlled and owned by families or their family members. For example, before his passing away, the hotelier Tan Sri Khoo Teck Phuat owned two firms (Central Properties Ltd. and Hotel Malaysia) out of the 157 publiclisted Chinese family firms. In the two instances, he accounted respectively for about 85 percent and 90 percent of the total substantial shareholdings. The selection of personnel for such key positions as chairmen, chief executive officers, and managing directors is another way through which family control of the firm is maintained. Although as generational shifts continue and younger executives are seeking to adopt more managerial and organizational practices popular in the US and Europe, still more than 90 percent of public-listed Chinese family firms in Singapore have family members holding key positions and/or have family members on the board of directors. For these firms, however, the family in question normally owns a majority portion of the shares. This ensures that the authority and importance of the family in the firm is not compromised. To illustrate, 83.3 percent

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of Centrepoint Properties Ltd. is owned by Fraser & Neave Ltd, in which the Overseas-Chinese Banking Corporation has a substantial stake. Other examples include the Overseas-Chinese Banking Corporation (owning 77.7 percent of Focal Finance Ltd.) and the United Overseas Bank (another ethnic Chinese family-based bank which owns over 70 percent of Hotel Negara). Of course, there are several forces that are pushing the above traditional model of corporate governance toward change and improvement. Some companies are hiring more outside managers. The modern heir may have not only an MBA degree from a prestigious university in the US or UK but also western notions of how to run a business. It is becoming clearer that opacity costs money as untrusting foreign investors demand bigger returns. In the external environment, these Asian countries are also looking for ways to protect minority shareholders. These might include, for instance, allowing minority shareholders who have voted unsuccessfully against a large transaction to insist that the company buy out their shares at the value prevailing before the transaction took place.

7.8 GOVERNANCE AND CORRUPTION Corruption has drawn the enormous attention of executives, directors, legislators, politicians, and scholars around the world. Recent debacles of many well-known companies, from the US’s Enron and WorldCom to China’s GITIC and Yuanhua Group, have further raised the profile of corrupt practices and their organizational repercussions. Anti-corruption is crucial to corporate governance because bribery and corruption damage the governance of corporations and impede efforts to develop corporate integrity. Corruption, or any illicit behavior, conducted by executives, managers, and employees can fundamentally deter the legitimate and long-term interests of internal and external stakeholders. On the other hand, good governance practices are important to prevent companies from being asked to pay bribes. In general, corruption is the conspicuous consequence of poor corporate governance, along with weak internal systems, non-existent controls and bad management, although poor corporate governance does not solely result in corruption.

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Anti-corruption becomes even more important to global corporate governance because international firms confront significantly varying norms, laws, and standards pertaining to business practices in general and corruption practices in particular. For instance, bribery is culturally ingrained as an acceptable business practice in some countries, such as some regions of Mexico, and kickbacks are common in selling activities in many parts of China. To cope with increasingly stringent anti-corruption law and, more importantly, to enhance the effectiveness and transparency of global corporate governance, more multinational corporations are voluntarily disclosing potential violations of anti-corruption laws. Not only can such public announcements minimize liability for nondisclosure, which was at the heart of many recent corporate governance scandals, but they may also reduce the reputational risk of being caught engaging in potentially illegal activities outside the home country. Surely it is true that anti-corruption necessitates efforts and commitments from various institutions, especially legislators, regulators, and government officials. Transparency in both the public and private domains is key in the fight against bribery and extortion. The business community, nongovernmental organizations, and governments and inter-governmental organizations all need to cooperate to strengthen public support for anticorruption measures and to enhance transparency and public awareness of the problems of corruption and bribery. The adoption of appropriate corporate governance practices is a complementary element in fostering a culture of ethics within the multinational enterprise. Still, however, companies or business organizations have an inescapable liability from such efforts and commitments. First, an organization is a basic unit of corruption practice. Most corruption activities take place between profit-driven organizations (bribers or donors) and government officials or legislators (corruptors or recipients). Second, organizations that are motivated to bribe for transaction-specific gains are partly responsible for the reason why corruption is difficult to eradicate. Unlike individuals, corrupt organizations cannot be “arrested” and thus only face legally-prescribed economic sanctions. Unless organizations are fully determined to resist corrupt practices, it is very difficult to fight corruption in a society. Third, an organization is a window through which to see a nation’s corruption

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climate. Corruption may be a passive reaction to cumbersome regulatory environments that impose a hurdle to business development or an active seeking of economic rents from corruption-generating opportunities. Anti-corruption is also critical to corporate accountability. For instance, the Foreign Corrupt Practices Act (FCPA) in the US, passed in 1977, revised in 1988 and further amended in 1998, clearly states the importance of anticorruption in fortifying firms’ global corporate governance and accountability. In fact, record-keeping and accounting constitute the main part of the Act and mutually reinforce anti-corruption. Accountability of transactions can significantly help the firm to detect and resist corruption practices. Poor accountability causes more bribery and corruption acts in several common ways. For instance, some transactions associated with bribery may not be recorded at all, or some records may be falsified to disguise a certain aspect of the transaction. The books may show a payment to “X” when the payment was actually made to “Y.” This presents the problem of mislabeling, which can arise if one company makes a legal but embarrassing payment and changes the records to mask the nature of that payment. In other cases, some records may be entered correctly but with a qualitative misrepresentation. For example, a payment of $100 000 to agent “X” may be entered when in reality there is an understanding that agent “X” will pay $20 000 to official “Y.” This problem is by far the most difficult to detect on audit.

7.9 TAXONOMY OF CORRUPTION Firms engaging in corrupt activities differ in the intensity scale and hierarchical scale of corruption, resulting in varying organizational identities, which display different levels of seriousness regarding the corruption involved. The intensity scale of corruption concerns the multitude (quantity) as well as the magnitude (gravity) of the corrupt activities. The hierarchical scale concerns the number of hierarchical levels (e.g., group/team-level, function/ department-level, division/subsidiary-level, and corporate/head office-level) that are directly involved in corrupt acts. When a firm engages in large scale and geographically diversified international businesses, especially in countries with rampant corruption, it runs the risk of heightened intensity

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scale as well as hierarchical scale of corruption. Unless a company has established and implemented an effective organizational system to combat and resist corrupt activities involving its employees, more foreign subsidiaries that are organizationally decentralized and operationally localized may increase the quantity of corrupt activities and involve more levels of hierarchies. Together, these two dimensions (intensity scale and hierarchical scale) jointly mirror the seriousness of organizational corruption. Specifically, intensity scale manifests the seriousness of the incidence of corrupt events while hierarchical scale reveals the hierarchical involvement of corruption within an organization. Organizational disease stemming from corruption is more severe along such incidence and extensiveness. The more hierarchical levels involved, the more severe the disease of corporate-wide corruption. These two dimensions are interrelated, yet distinct. They may reinforce each other such that the more hierarchies that are involved, the greater the intensity of the corruption that is likely to occur. Yet they describe differing aspects of organizational engagement. Most frauds within a large organization take place in a low level of the hierarchy, meaning that managers on the bottom of the organizational structure are responsible for the organizational corruption. Likewise, there are organizations whose corruption is small in scale, but that involves top-ranked senior executives. Using the intensity scale and the hierarchical scale as two axes, four metaphorical identities emerge (see Figure 7.1): (1) mad fox (high intensity and more hierarchies); (2) errant rabbit (low intensity and few hierarchies); (3) sick bulldog (low intensity and more hierarchies); and (4) wild puppy (high intensity and few hierarchies). As I will explain later, organizations with differing identities may live in different environments, act with different behaviors, bear different consequences, and require different architectures. A mad fox is a metaphor for a company where a large number of managers and employees at many hierarchical levels or in various subunits perform corrupt practices, resulting in very serious illegalities. The mad fox metaphor thus infers the illness of a whole company in which both the intensity scale and hierarchical involvement have reached very high levels. Within an organizational structure, managers at function-, business-, and corporate-levels actively and extensively participate in corrupt activities or collude with external stakeholders to achieve certain objectives that are, as

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NUMBER OF HIERARCHIES NVOLVEED Less More

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Sick Bulldog

Mad Fox

Structural Malfeasance

System Malfeasance

* Leveling ** Pacification

Errant Rabbit

* Positioning ** Control

Wild Puppy

Procedural Malfeasance

Categorical Malfeasance

* Bridging ** Acquiescence

* Interpenetration ** Selection

LOW

HIGH CORRUPTION INTENSITY

* Tactics to align with task environment pressures for corruption ** Tactics to align with institutional environment pressures for corruption

Figure 7.1. Taxonomy of corrupt organizations.

they perceive, in the interest of the firm. The worst scenario among the four identities, this type of firm often holds some rationalizations that lead to misconduct, including (1) a belief that the activity is within reasonable ethical and legal limits; (2) a belief that the activity is in the subunit’s or corporation’s best interests; (3) a belief that the activity is “safe” because it will never be known or publicized; and (4) a belief that because the activity helps the firm, the firm will condone the activity and even protect the person or people involved. Although some of these beliefs may also occur in other scenarios, the magnitude of these beliefs is strongest in the mad fox. An errant rabbit is a metaphor for a company in which intensity and hierarchical scales of corruption are both very low, implying fewer instances of misconduct, narrower hierarchical involvement, and a weaker plague from corruption compared to other metaphors. It is nonetheless errant, involving illicit practices that firms with good business ethics would not perform. Misconduct in this type of firm is not structurally systematic but is occasional

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or spontaneous, typically performed by a few employees at lower level hierarchies. Even with programs to resist corruption, some companies may still engage in errant rabbit behaviors because of difficulties in governing the implementation of these programs at business- and function-levels. For most companies undergoing pyramidal politics (i.e., decentralizing power to every lower hierarchy), errant rabbit behavior is likely to arise unless the system of enforcing counter-corruption policies is effectively and endurably functioning. A sick bulldog is a metaphor for a company whose corrupt activities are not intensive but are nonetheless the practice of executives, managers, or employees at many different levels. In spite of low intensity, organizational breadth is high and many levels of the hierarchical structure are involved. This type of firm is “sick” because corrupt practices spread to so many hierarchies that the entire body of the firm is contaminated. It is true that many large corporations today consist of a conglomerate of subunits, each with its own management. It is ultimately the individuals within each unit or department that make decisions and compromises or that react to external environments. However, this conglomerate system is an integrated moral and social entity responsible for business-related misconduct by individuals who represent the company. Although it does not produce a large number of corruption events, the sick bulldog behavior massively harms the entire organizational morality. Misconduct is typically caused by two connected structural mechanisms — corporate structure (tasks, responsibilities, rules, and procedures for individual members) and corporate culture (ideas, expectations, values, visions, and customs shared among individual members). The roots of a sick bulldog reside in the malfunctioning of both structural mechanisms. Lastly, a wild puppy is a metaphor for a company in which most corruption is narrowly concentrated at one or a few levels of the hierarchy. This metaphor is characterized by large scale corrupt practices that are primarily performed by employees at one or few narrow levels of the firm. The adjective “wild” is used to symbolize a rampant situation of bribery, fraud, or other illicit activities occurring at one level or in one subunit. The majority of these activities are localized in a level of the hierarchy that lacks moral conscience. It is natural that responsibility increasingly diffuses and fragments when a company decentralizes its complex operations and

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deploys distinctive resources to subunits. Accordingly, it is possible that one subunit, which can work independently to produce harm, may be responsible for most of the corporate-wide wrongdoing. In this instance, if evidence of potential harm is unassembled and fragmented and if corporate- or parentlevel executives do not strive to suppress and exterminate subunit behaviors through integrated codes of conduct, a wild puppy may transform into a mad dog, dwarfing the healthy growth of an entire firm.

7.10 CORRUPTION AND ORGANIZATIONAL ENVIRONMENT Organizational corruption is attributable to both corporate and environmental factors. The impact of country-level environmental dynamics — whether economic, political, legal, or cultural — on national-level corruption has been rigorously studied. Corruption derives from numerous environmental factors, notably distorted or opaque governmental behavior and decisions, weak counter-corruption institutions, cultures that intertwine gift-giving with bribery, ambiguous business–government relations, subtle networking practices, shortage of independent and well-functioned market mechanisms and institutions, poor quality of public service, low salaries in the public sector, influence of an underground economy, strong linkage between officials and family businesses, deficiency in democratic power-sharing formulas, weak media functions, and inadequate openness in trade and market access. Here I intend to emphasize how the organizational environment facing a company’s various units, whether divisions or subsidiaries, influences organizational corruption. Organizational theorists suggest that a firm’s behavior, strategy, and response are shaped by its organizational environment, which is composed of both task and institutional constituents. The task environment pertains to external resources, information, or conditions that may immediately affect goal setting and goal attainment. The institutional environment pertains to the external needs and requirements to which individual units of a company must conform in order to receive legitimacy and support. Here I focus on three traits of the task environment in which a specific unit of a company operates, namely (1) oligopolistic intensity;

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(2) regulatory control; and (3) structural uncertainty, and three traits of the institutional environment, namely (1) institutional transparency; (2) institutional fairness; and (3) institutional complexity. In my view, these environmental traits represent well China’s task and institutional environments facing most companies operating there today. Organizational corruption increases or decreases when conditions in these environments change. It is true that firms may also be able to shape, at least to some extent, these task and institutional environments (corruption itself may be one of the means for this purpose). Here I intend to illustrate how corruption is influenced by these task and institutional conditions that already exist. Specifically, I suggest that, all else being equal, oligopoly, regulation, and uncertainty, together with institutional opaqueness, injustice, and complexity escalate pressure for corruption and increase the probability of its incidence for a company’s individual units that operate in this type of environment. Whether or not this pressure will eventually transform into real corruption, however, depends in large part on a company’s moral consciousness and related programs combating corruption. Moral consciousness concerns the extent to which a company’s leaders and employees are aware of the moral goodness or blame-worthiness of their own behavior, together with a feeling of obligation to do the right thing. In my view, moral consciousness is a prerequisite for moral behavior. Although a corporation is a juristic and not a real person, society has the right to look at its moral consciousness to see to what degree its moral behavior conforms to a social standard of what is right. Moral consciousness and related anti-corruption programs are thereby likely to be either a conditioning factor or a moderating factor, affecting the form or strength of the link between corruption and the environment.

Corruption and Task Environments Although they may not be completely inclusive, oligopolistic intensity, regulatory control, and structural uncertainty are proposed as the ingredients constituting the task environments of corruption. Task environments include the elements that actively and directly cooperate and compete with the focal units of a company. They interact with the firm units through resource dependency

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and information uncertainty. Task environments affect firms through the process of making available or withholding resources and information. Oligopolistic intensity and regulatory control reflect a focal unit’s resource dependency on competitors and regulators while structural uncertainty indicates the variability of industry structural information that drives up the costs of transactions and coordination for the firm. Both dependency and uncertainty are viewed as salient parameters affecting business strategy and corporate response. The way a company reduces such dependency or uncertainty in order to cope with these conditions will affect that firm’s outcomes. Oligopolistic intensity describes the extent to which a small group of firms in the focal industry have dominant control and market power in the industry. If a corrupt firm is a member of this group, it will be motivated to continually bribe officials in power or collude with other members of the group in order to retain its advantageous position. It also has a monopolistic power to distort, withhold, or hide the industry’s structural information needed by other business stakeholders (suppliers, buyers, new entrants, and small rivals). In this case, abnormal economic returns are not created from building blocks of competitive advantages but from a corruption-based monopoly. If an oligopoly is threatened to be reduced by governments, the company may even fortify its corruption. Competitive pressure arising from deregulation or privatization will challenge the sustainability of market power and the advantageous position already occupied by the oligopolistic firms. From the perspective of a corrupt government agency, oligopoly motivates public servants to seize parts of economic rents obtained by oligopolistic firms using extortion and corruption. For a morally unconscious company not belonging to this oligopolistic group, the incentive to bribe is also present. Because of the liabilities of newness, smallness, or remoteness (i.e., not close to political authorities), a firm outside this group spends more in accessing the focal industry, confronts pressure to follow oligopolistic firms’ pricing and policy, and encounters greater difficulty in utilizing upstream inputs or downstream resources controlled by oligopolistic players. Morally unconscious executives may think that corruption with political or bureaucratic authorities can help the company secure a foothold or privileges (financing, taxation, distribution channel, or procurement) so as to neutralize its foregoing liabilities. A weak outsider may also bride decision-makers in a monopolistic firm to obtain

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a subcontract, which provides some specialized services needed for the latter’s value chain activities. Regulatory control is concerned with the extent to which government authorities regulate and intervene in various industrial policies such as market access, capital investment, technological standard, distribution channels, and environment protection which may significantly impact business operations in a focal industry. Executives at subsidiaries participating in an overly or poorly regulated industry may use more corruption to countervail changing and uncertain regulations. From the information uncertainty viewpoint, excessive or poor regulatory control, which is often nontransparent and unstable in most emerging economies, increases the costs of information scanning and processing. From the resource dependence viewpoint, excessive or poor regulatory control, often conducted by controlling key production inputs such as land, natural resources, and capital, increases the costs of strategic planning and creates difficulties in maintaining flexibility. In the mind of ethically questionable managers, bribing officials can help the company reduce information costs, lighten the regulation’s hindrance, or obtain institutional privileges. Under this presumption, there may be a positive link between excessive, poor, or uncertain regulatory control and corruption intensity for companies lacking business ethics. The practice of “getting in by the back door” used by many Chinese companies, especially those in a weak market position, illustrates this link. In the past four decades, whenever regulatory control heightens, “back door” activities intensify. Structural uncertainty describes the extent to which an industry’s structural attributes such as demand and supply are volatile and unpredictable. This uncertainty implies an absence of sufficient information about industry structure and its changes. It also implies executives’ inability to predict these changes and their impact on organizational decision alternatives. Since this uncertainty is largely caused by changes in government policies, ethically questionable executives at subsidiaries operating in this type of industry may aggressively bribe officials in power to obtain insightful information and a lead on unreleased new policies. Such “insights” may transform into short-term privileges, which enable the corrupting firm to occupy a superior position in the market or grasp some early mover opportunities. Institutional economics holds that structural uncertainty propelled by industrial policy

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is significantly more difficult for firms to predict, respond to, and cope with than structural changes caused by market disequilibrium itself. In this situation, executives are apt to emphasize personnel interlocks with officials to trade upon ambiguity. For morally unconscious executives, such interlocks may become corruption acts. In a society lacking organizational morality and anti-corruption systems, corruption may be portrayed as more prompt, direct, and effective than socialization-based interlocks in the eye of ethically ill-behaved executives.

Corruption and Institutional Environments Institutional environments serve as conditioning factors that either undercut or entice organizational corruption. This study proposes that institutional transparency, institutional fairness, and institutional complexity are important components of these environments. Both task and institutional environments simultaneously place pressures on a company’s units in such environments, to which they are forced to respond. But the types of pressures vary between the two. Task environments affect business operations through structural forces which impact input and output. Institutional environments affect business operations through legal, regulatory, socio-cultural, and professional requirements that impact the costs of maintaining organizational legitimacy. Institutional theorists emphasize that institutional rules and requirements themselves are important types of resources and that those who shape them (e.g., state, regulatory bodies, or professions) possess a valuable form of power. Institutional requirements affect organizational arrangements through both cognitive and normative mechanisms. In most emerging markets where firms are increasingly active, professional organizations (e.g., auditing, arbitration, and taxation) and trade associations or unions are virtually stateinstituted. As a result, they are parts of broadly defined regulatory institutions. Institutional transparency and fairness essentially describe the transparency and impartiality of the regulatory system. While transparency and fairness reflect the degree of openness and nondiscrimination of institutional rules and requirements, complexity displays the level of difficulty in coping and adapting to regulatory systems and socio-cultural environments.

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To most firms, the institutional environment may exert a relatively stronger effect on the incidence of their corrupt activities than the task environment mentioned above. Institutional hurdles and barriers amplify the liabilities of foreignness. To curtail such liabilities, morally conscious firms with rich resources and capabilities may use their competitive advantages to compensate for their disadvantageous positions in the wake of foreignness liabilities. Morally unconscious firms, especially when they do not possess competitive advantages suitable to host country operations or when their possessed competitive advantages cannot be effectively exploited due to the poor infrastructure for investments and operations in a host country, are likely to use bribery or other illicit methods to overcome their liabilities of foreignness arising from institutional hurdles, particularly discriminatory treatments against foreign companies. More specifically, institutional transparency describes the extent to which regulatory systems (political, bureaucratic, industrial, and professional) are open, clear, and easy to understand in a particular country in which a company’s unit invests and operates. This transparency is especially low in regulated industries in most emerging economies (e.g., telecom, automobile, insurance, media, retailing, and banking) and with respect to issues such as project approval, market access, environmental standards, and requirements for gaining taxation exemptions or holidays. The lack of experience by regulatory bodies in administering many experiment-type practices is a main reason for this opaqueness. In turn, this opaqueness provides regulatory authorities and individual bureaucrats with the exclusive right to explain and interpret ambiguous rules and requirements which leads in part to business-regulatory body corruption. In this circumstance, corrupt officials realize that the opaqueness propels the dependence of some businesses on the officials, thus facilitating the transformation of regulatory power into monetary gains. Morally unconscious executives, especially in companies more prone to these regulations, may realize that bribery is the only way to acquire regulatory insights or to skew new rules toward a direction that agrees with the firm’s interests. Institutional fairness describes the extent to which various regulatory treatments (political, bureaucratic, industrial, and professional) are impartial, just, and nondiscriminatory to every business, including foreign business, within the institutional reach. During structural reforms, most transition

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economies are characterized by regulatory heterogeneity across regions, locations, sectors, industries, ownerships, and often between domestic and foreign firms. Previously controlled policies are increasingly becoming idiosyncratic and discriminatory according to these parameters in a bid to redress structural distortions or regional disparities caused by a long period of a centrally planned economy. As a negative derivative of this change, many businesses, especially those close to government authorities, are able to receive institutional privileges that other businesses do not have. Institutional privileges include, but are not limited to, tax relief, favored financing, fiscal subsidy, exclusive rights in using certain resources, government protection, ensured early mover position, special rights in using governmentally instituted distribution or export channels, and heightened entry barriers against new rivals. Granting these privileges can directly foster business–government corruption and business–business collusion. Privileged group members, by exploiting their monopoly power and institutional advantages, are able to seize more economic rents than non-group members. This motivates morally unconscious executives to bribe bureaucrats who have the power to decide this membership in exchange for institutional privileges that are considered of high value. With more unfairness, firms encounter a stronger pressure to bribe in order to remain in this institutional environment. Finally, institutional complexity describes the extent to which the institutional environments (regulatory systems and socio-cultural environments) that a company or its units must relate to are complicated and difficult to verify, analyze, comply, and cope with. The information processing view holds that complexity increases the information processing and agency demands facing the firm and its top executives. The firm must develop information processing mechanisms capable of dealing with this complexity. Executive interlocks with bureaucrats and leaders in other stakeholder groups are one such mechanism. It is generally harder to internally absorb and process required information in emerging economies than in advanced market economies because of opaque and uncertain regulatory systems, diverse and peculiar socio-cultural environments, and lack of market-supporting institutions. When facing such complexity in an advanced economy, executives can go on the market to find agencies or persons (e.g., experts at consulting companies or law offices) who can interpret and deal with these regulations. Such services,

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however, are virtually lacking in most emerging markets and developing economies due to the facts that the market service sector has not yet been developed and that institutional complexity itself is difficult to analyze by organizations and professionals. In this context, when executives cannot find a professional agency nor are able to process complex information by themselves, they are more likely to bribe those bureaucrats or leaders in various segments of institutional environments who can provide authoritative insights and credit-worthy information. They may expect that such insights will help dispel the threat of institutional complexity on business development. In markets in which corruption persists and there is a failure to punish corporate illegalities, this likelihood increases. In conclusion, this section defines task environments (oligopolistic intensity, regulatory control, and structural uncertainty) and institutional environments (transparency, fairness, and complexity) that partly explain organizational malfeasance in corruption involving a company’s various units in these environments. I illustrate the logic that corruption may increase along degrees of oligopoly, regulation, and uncertainty and decrease along degrees of transparency, fairness, and simplicity. These testable propositions, however, should be viewed in a larger context wherein political, legal, economic, historical, and socio-cultural causes of corruption are also taken into account. In fact, the task and institutional environments that this study emphasized are intertwined with these causes. For instance, institutional transparency reflects the superiority of political and legal systems while oligopolistic intensity is a product of economic, political, and legal conditions, which affect industrial structure. The extent to which these task and institutional environments will actually provoke corruption depends largely on a company’s moral consciousness and support programs that combat corruption. Different organizational metaphors may use varying tactics to respond to different task and institutional environments, thus presenting different firm behaviors associated with illicit acts.

7.11 CORRUPTION AND ORGANIZATIONAL BEHAVIOR This section emphasizes a company’s malfeasant behaviors in its corrupt practices. Specifically, it attempts to use a typology to elucidate which

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deviant behaviors will be used by organizations with differing metaphors to align with the above task and institutional environments. A typology of malfeasant behaviors is useful for a better understanding of organizational corruption and giving parsimony and order to the diverse set of behaviors that comprise organizational deviance on corruption. Malfeasant behaviors are opposed to ethical behaviors in that the former focuses on behaviors that violate rules specified by a given political, social, and legal context, whereas the latter focuses on behaviors that are considered right as judged in terms of justice, law, or other societal guidelines determining organizational morality. I conjecture that a mad fox metaphor is accompanied with system malfeasance, an errant rabbit with procedural malfeasance, a wild puppy with categorical malfeasance, and a sick bulldog with structural malfeasance.

System Malfeasance System malfeasance exists when an entire organizational system is contaminated with corrupt acts and corporate illegalities. The mad fox metaphor applies well here because it involves system-wide fraud characterized by a great magnitude of corrupt activities carried out by many hierarchies. Here, malfeasance is both intensive and extensive, plaguing the whole system tantamount to a cancer. A mad fox metaphor assumes that the benefits of corruption outweigh the costs of corruption, thus permitting senior executives and board members to be involved in bribery and tolerating managers and employees at lower levels with such deviant behavior despite the risks of legal sanctions and reputational damage. Corresponding to system malfeasance, a mad fox metaphor may emphasize positioning to align with structural uncertainty, regulatory control, and oligopolistic intensity and focus on control to align with institutional opaqueness, injustice, and complexity. Positioning is a tactic that seeks a strong position in oligopoly, bargaining with regulatory bodies and reducing uncertainty through corruption. Among the four metaphors, a mad fox is the most aggressive in corruption, attempting to secure an advantageous position for maximizing possible gains from task environments via illegitimate means. Control is a tactic that seeks to influence, shape, and dominate institutional

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environments through corruption. A mad fox metaphor intends to establish power and dominance over institutional constituents which apply pressure on the firm. To this end, it uses corruption to manipulate institutional processes such that institutional opaqueness, injustice, and complexity may hamper other firms but not itself, or provide it with new benefits, via exceptions, concessions, secrecies, or privileges.

Procedural Malfeasance Procedural malfeasance exists in the errant rabbit metaphor whose formalized procedures on business ethics are not strictly followed by some employees at one or few levels or in one or few subunits, resulting in a low scale and a narrow scope of illicit acts. In a highly decentralized system, one or a few subunits may face explicit normative or coercive pressures in a particular task and institutional environment that require bribery under threat of losing deals, concessions, or privileges by corrupt officials. Employees in a subunit may assert that if they do not make payoffs, a less competent rival will win such deals, concessions, or privileges. In other cases, some employees in a remote location or subunit may believe that payoffs are a routine part of doing business there and are indigenously acceptable. If the implementation of corporate programs alleviating illegalities is not strictly monitored, some individuals may find leeway to escape blame and punishment. Under these circumstances, low intensive corruption with few hierarchies involved occurs, despite the existence of company-wide procedures for resisting corruption. In conformity with procedural malfeasance, an errant rabbit may consider bridging to configure with task environments and use acquiescence to configure with institutional environments. Bridging is a tactic that seeks connection with relevant stakeholders in task environments such as regulators, competitors, suppliers, buyers, and distributors. An errant rabbit metaphor involves low-scale corruption on a sporadic or occasional basis in an effort to cultivate, through corruption, relationships with the task environment community. Managers in some new firms may think that bridging through corruption is a shortcut to connect with outsiders who control input and output resources on which the firm depends. Acquiescence is a tactic that unwillingly accepts, follows, and mimics corrupt acts already conducted by

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other firms to deal with the same institutional environments. An errant rabbit metaphor tolerates some employees’ illicit behaviors that are necessary for coping with institutional hazards. In this case, the pressure for corruption comes from institutional requirements rather than from an organizational intention for corporate illegality.

Categorical Malfeasance Categorical malfeasance exists in a wild puppy metaphor in which many corrupt practices are concentrated in one or few categorical levels (teamlevel, functional-level, business-level, or corporate-level), categorical units (group, department, division, branch, or subsidiary), or categorical locations (domestic vs. foreign, developing vs. developed countries, or within vs. beyond the regional bloc). This type of malfeasance is not systematic and extensive throughout the entire company, but instead it ascribes mainly to a few managers in one or a few of these categories that conduct a great deal of serious corruption. In a highly diversified structure, various categories face idiosyncratic task and institutional environments relating to corruption. Because this structure is also decentralized and provides categorical managers with adequate decision power, it becomes possible that corruption varies across categories. Malfeasance may increase when (1) one category or unit confronts strong bribery pressure from its task and institutional environments; (2) it has difficulty in fulfilling short-term financial goals set by its parent; (3) it is dysfunctional and mismanaged; and (4) senior managers in this category despise or overlook illicit behaviors. Categorical malfeasance is further revealed in the way a wild puppy metaphor deals with its task and institutional environments. It may emphasize interpenetration to deal with task environments and use selection to deal with institutional environments. Interpenetration is a tactic that seeks to influence task environment constituents, which affect a focal categorical level, subunit, or location. In doing so, it bribes those with decision power in order to create favorable task environments that will permit the problem puppy to grow. As a malfeasant behavior, interpenetration may confer a strong position in oligopoly, infiltrate industrial regulation, and yield confidential insights into industrial environments. Selection is a tactic that seeks to manipulate

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institutional environments facing the categorical level, location, or unit that is heavily involved in corruption. It thus emphasizes corrupt acts in selected areas. Because it is impossible for any organization to manipulate the entire institutional environment due to the latter’s exogenism and residualism, selection is a reasonable behavior consistent with categorical malfeasance.

Structural Malfeasance Structural malfeasance exists in the sick bulldog metaphor where corruption acts are structural in nature and most levels of the hierarchy, if not all, are involved, despite the fact that the latter are small in scale in terms of quantity and gravity. When a company is highly integrated (vertically or horizontally) or centralized (along functions or areas), it increases the probability that corruption practices are collectively performed by, or jointly involved with, multiple levels of the hierarchy. This is the case of corruption sharing. When a company is structurally decentralized but each hierarchical level or subunit faces strong pressure to perform illicit acts and lacks clear codes of business conduct enacted on its own or by the head office, it increases the probability that corrupt acts will simultaneously yet independently take place at multiple levels or in multiple subunits. This is the case of corruption multi-location. In either case, malfeasance is structural not only because it occurs at many hierarchical levels but also because it marks the firm’s failure to correct this system-wide defect through structural measures such as harmonized anti-corruption programs and responsibility-sharing systems across hierarchical levels. Although structural malfeasance involves less intensive corruption than system malfeasance, the former can transform into the latter if the firm allows the illness to remain. A sick bulldog may focus on leveling to align with task environments and on pacification to align with institutional environments. Leveling is a tactic that seeks to smooth the impact of the task environments’ fluctuations on business operations. Under structural malfeasance, leveling is achieved through bribing or colluding with decision-makers in task environments to motivate suppliers of inputs, stimulate demand for outputs, or influence bureaucrats of regulatory authorities. Unlike a mad fox metaphor that relies on aggressive positioning in order to dominate in the task environment, a sick

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bulldog attempts to reach out into the task environment through corruptionbolstered smoothing in order to reduce fluctuations in its input or output environments. Pacification is a tactic that seeks to appease institutional constituents for the entire firm. Corroborating structural malfeasance, pacification mounts a low intensity of corruption but devotes most of the corruption resources to placating institutional pressures encountered by the whole firm. Corruption is performed to accommodate demands for bribery, gratuities, or payoffs from politicians and bureaucrats who have the power to manipulate institutional transparency, fairness, and complexity which influence the entire company’s business activities. In conclusion, this section discusses the organizational behavior of different metaphors and how this behavior may be configured with the task and institutional environments identified in the preceding section. I suggest that a mad fox may respond to task parameters through positioning and to institutional parameters through control, together presenting systematic malfeasance. An errant rabbit may respond to task environments through bridging and to institutional environments through acquiescence, together presenting procedural malfeasance. A wild puppy may respond to task constituents through interpenetration and to institutional constituents through selection, together presenting categorical malfeasance. Lastly, a sick bulldog may respond to task pressures through leveling and to institutional pressures through pacification, together presenting structural malfeasance. All these behaviors and underlying methods in response to task and institutional environments are illicit, immoral, unethical, and illegal. Case studies are needed in the future to substantiate this line of discussion and advance our understanding of illicit tactics in different scenarios. Firms with these deviant behaviors fail to fully realize their serious consequences, both visible and invisible.

7.12 CORRUPTION AND ORGANIZATIONAL ARCHITECTURE Corruption is a durable and adaptable virus. Combating corruption requires a set of measures at various levels including addressing poverty and inequity

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(social aspect), enacting and enforcing anti-corruption law (legal aspect), improving democracy, media freedom, and civil service (political aspect), and reforming dysfunctional governments (regulatory aspect), among others. Aiming at presenting an organizational logic of corruption, this study suggests that, in addition to the above legal, social, political, and regulatory measures, the corporate community is also an important force in combating corruption. Anti-corruption in any society cannot succeed unless it is addressed by individual organizations. Anti-corruption at the organizational level is institutionalized through an organizational architecture which is composed of (1) culture; (2) structure; and (3) system. An effective organizational architecture is one that ultimately yields intended results, namely, education, detection, and deterrence, through an interlaced corporate culture, organizational structure, and compliance system.

Corporate Culture Corporate culture sets the moral tone for a company. Corporate culture is defined here as the statements, visions, customs, slogans, values, role models, and social rituals that are unique to, and used by, a focal company to resist corrupt practices. The cornerstone of an organizational architecture combating corruption is the detailed anti-corruption statement which guides managers in how to make day-to-day decisions. Such statements should be instrumental rather than principle in tone. They can suggest that there is no inconsistency between profitability and refusing to bribe. Or they can state that the firm will not compete for business where bribery is a requirement. Firms should have detailed procedures for disseminating their anti-corruption statements to employees in all hierarchical levels, subunits, and locations. An effective architecture for resisting illicit conducts necessitates a multi-faceted anticorruption effort that promotes a compliance culture within the entire firm. Visions and commitments from leadership (e.g., board of directors, CEO, general counsel, CFO, Chief Internal Auditing, and regional or country manager) play a significant role in squashing corruption. Ethical leadership sets the moral standards for a company by focusing on the integrity of common purpose. These leaders should be champions and role models who lead anti-corruption efforts. Role models are important in setting a positive

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ethical climate because humans as social beings are influenced by other humans. Without sufficient commitment from the leadership, it is impossible for a company to position itself as a good citizen that is concerned with honest business practices and the need to maintain a level playing field in domestic or global markets. Identifying corruption by these leaders as a threat to a company’s long-term health and growth serves important strategic interests. A company should also take reasonable measures to communicate its anti-corruption culture and values in an open environment to encourage participation and feedback. Employees should be informed to whom they should report violations or ask questions. Anti-corruption is widely incorporated in many firms’ corporate culture statements and/or ethical codes. A typical example would be: “The Company has had a longstanding policy forbidding bribery of government officials in the conduct of its business. The Company also expects its employees to comply with all related laws prohibiting the making or offering of any payment to any official to induce that official to affect any governmental act or decision or to assist the Company in obtaining or retaining business. No Company employee anywhere in the world may make a bribe, payment, or gift to any government official whether or not there is an intent to influence. The Company takes this position not only because such bribe, payment, or gift would be in violation of the law, but also because of the Company’s commitment to good government and the fair and impartial administration of the law.” A more specifically stated example would be: “… Bribery, or the giving of money or anything else of value in an attempt to influence the action of a public official, is unlawful. All employees are not authorized to pay any bribe or make any other illegal payment on behalf of the Company, no matter how small the amount. This prohibition extends to payments to consultants, agents or other intermediaries when you have reason to believe that some part of the payment or ‘fee’ will be used for a bribe or otherwise to influence government action.”

Organizational Structure Misconduct can be detected and corrected through organizational structure since this structure establishes the content of the jobs, specifies a monitoring

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process, and regulates ways to fulfill tasks and responsibilities. Because many corrupt acts are actually performed by individual employees on behalf of the company, which is often defined as an autonomous moral entity, it is critical to maintain corporate integrity. Integrity is the disposition and behavior directed at realizing the wholeness of the company. Formal structure is a necessary mechanism to maintain this integrity and realize legitimate moral expectations in a coherent manner. When a company is highly decentralized, corporate or headquarters’ control of anti-corruption policies and procedures through integrated structure is imperative for integrity. Apart from structural formalization to educate, detect, and rectify illicit behaviors, a company may also establish an anti-corruption committee and appoint a corporate compliance officer within an existing structure to better deter corrupt activities. This committee or officer can play key roles in drafting codes of conduct and educating and training employees on compliance procedures. Committee members may include senior vice presidents for marketing and sales, auditing, operations, human resources, and other key officers. Empowering compliance officers with access to senior members of management and with the capacity to influence overall company policy on integrity issues is of utmost importance. Transparency throughout the entire organizational structure is a necessary condition for reducing the potential for illicit dealings. Record keeping and reporting are procedures that the firm can use to document key aspects of its compliance effort and to monitor its program for effectiveness. Even the reporting of minor incidents within the firm can serve a useful purpose in underscoring a zero tolerance policy for questionable behaviors. The failure to report such occurrences may lead to the perception that such irregularities will be tolerated. Auditing and monitoring of systems of internal accounting controls also contribute to building an effective system by detecting corporate malfeasance early on. Firms should have a clear and concise accounting policy that prohibits off-the-books accounts or inadequately identified transactions. They should monitor their accounts for deceptive bookkeeping entries that may disguise illegal bribery. Structural mechanisms that enforce anti-corruption programs and policies must be in play. Creating reporting mechanisms with adequate

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policies on confidentiality and non-retaliation as well as other safeguards related to reporting is extremely important. Despite best efforts, no firm can be certain that the necessary element of trust is present in all formal reporting relationships. Whistle-blowing systems can help to achieve open communications when ordinary channels fail. A company should ensure that all employees understand that failure to comply with its anti-corruption policy and procedures will result in disciplinary action, ranging from minor sanctions to more severe punishment, including termination of employment. A good communications effort (e.g., hotlines or helplines) can build employee confidence that the firm will not tolerate either retaliation against whistleblowers or false reporting.

Compliance System The compliance system that suppresses corruption consists of conduct code and ethics programs, together constituting an effective organizational control that minimizes corporate illegalities. This control makes information and expectations about legal and ethical behaviors clear, increases the likelihood of detection, assures the punishment of transgressions, rewards desired behaviors, and disciplines those who engage in illegal behavior.

Conduct code This system begins with written commitments in areas of business ethics that are relevant to the firm’s activities — that is, a code of corporate conduct that provides a set of legal and ethical guidelines for employees to follow. Such codes are voluntary expressions of commitment, made to influence or control business behavior for the benefit of the firm itself and the communities in which it operates. A corporate code of conduct generally consists of a clearly written set of legal and ethical guidelines for employees to follow. A comprehensive and clearly articulated code of conduct, as well as clear policies and procedures relative to seeking guidance and making disclosures may reduce the likelihood of actionable misconduct by employees. The codes

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seek to heighten employees’ awareness of corporate policy and enlist their support in the fight against corruption acts. They also draw a distinction between the acceptable quid quo pro and networking that are necessary to develop business relationships and corrupt practices. Codes can contain general precepts and mandate specific practices, providing clearly stated provisions that deal with legalities and ethical concerns and detail sanctions and enforcement including the methods of investigation and detection. It is important that a company’s code of conduct be distributed to everyone in the company, and if necessary, translated into the languages of the countries abroad where a company invests. Finally, developing a code of conduct should not be the final act. The code must be effectively implemented and enforced at all times. To ensure the effective enforcement of a company’s code of conduct, compliance officers should be accessible so that employees will feel comfortable discussing any of their compliance questions or concerns. In this regard, creating reporting mechanisms with adequate policies on confidentiality and non-retaliation as well as other safeguards related to reporting is extremely important. Whistle-blowing protections or helplines facilitating detection and reporting of questionable conduct will further help. Here are two examples illustrating such codes for a US company operating in China. The first one deals with the code that specifies how to deal with local consultants and intermediaries. The second example illustrates a general statement of the code regarding the resistance of corruption in international business activities. (1) Commission or fee arrangements shall be made only with firms or persons serving as bona fide commercial representatives, agents, or consultants. Such arrangements may not be entered into with any firm in which a government official or associate is known to have an interest unless the arrangement is permitted by applicable law and has been specifically approved by the company’s general counsel. All commission and fee arrangements shall be by written contract. Any commission or fee must be reasonable and consistent with normal practice for the industry, the merchandise involved, and the services to be rendered. Payments shall not be made in cash. An

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associate may not take any action or authorize any action which involves any illegal, unethical, or otherwise improper payment of money or anything else of value. (2) When conducting business in other countries, laws and local customs and practices will be encountered that differ from those in the United States. The Company’s policy is to comply with all laws that apply in the countries where we do business. In countries where common customs and practices might indicate acceptance of standards of conduct different from those to which we aspire, employees should continue to follow the more stringent code of conduct, subject to reasonable business judgment. The Company’s policy prohibits the making of any payment in violation of the US Foreign Corrupt Practices Act. Except as provided in this section, all payments are forbidden to officials or employees of governments or government-owned or related agencies. In some areas of the world, timely action by low-ranking government employees can be obtained only by generally accepted payment of modest gratuities. Payment of modest gratuities to induce a person to do only what he or she is required to do and to which the company is legally entitled is permissible if it clearly conforms to local custom. However, such payments should not be made as a matter of course; they should be the exception and not the rule, and should be considered only in circumstances where proper alternatives are not meaningfully available. Such payments must be properly recorded on the books of accounts. In no circumstances are any such payments to be made to any official or employee of any governmental entity or government-related entity of any US jurisdiction. While it is difficult to monetize “modest gratuities,” local practice and good judgment should always be applied. In one country, the expediting of customs clearance for a product sample may require payment of a nominal sum, while a commercial shipment of a perishable or urgently needed item might require payment of a greater amount. In any event, should it appear that significant payments are required under conditions that would make failure to deliver extremely expensive, the Chief Financial Officer of the Company should be contacted promptly for resolution. Such disbursements should be recorded as “facilitating payments.”

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Compliance program Compliance programs (e.g., training, due diligence, and formalized procedures) ostensibly bring the behavior of firm members into conformity with a shared ethical standard. They constitute an organizational control system that encourages shared ethical aspirations and compliance with rules. Combating corruption requires legal and ethics training at every level of a company. Regular ethics and compliance training programs should be held for all company employees, including board members and senior management officials. It may be also necessary to educate overseas employees about host country’s anti-corruption laws. For instance, foreign employees may be often confused with respect to the use of “facilitating” fees (payments to obtain such items as licenses, permits, or police protection), which are legal and customary in some developing countries. In this case, the company’s welldefined policy as to how to handle such facilitation fees should be included in the training program of expatriates who are about to be dispatched. According to the FCPA, companies are allowed on occasion to make a minor payment to a foreign government employee whose duties are essentially ministerial or clerical in nature. This minor payment is usually for the purpose of expediting rather than influencing a particular decision. It is made simply to expedite some matter in a more timely or efficient manner. Facilitating payments (sometimes called “grease payments”) may not be illegal under the FCPA or foreign government law enforcement policies and customs; however, in certain instances, such payments may be violative of local law enforcement policies or of other Federal statutes, particularly if they involve substantial amounts. If they involve large amounts or if otherwise material, public disclosure under SEC regulations, as noted above, may also be required. Facilitating payments must be strictly controlled and every effort must be made to eliminate or minimize such payments. Facilitating payments, if required, will be made only in accordance with local custom and practice. Recognizing that some confusion may exist as to the propriety of making facilitating payments, such payments should not be made except under the guidance of the company’s legal department. In addition, more specific legal and ethical training may be necessary for employees in high-risk and high-corruptive areas. A company should

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also take reasonable measures to communicate its values and procedures in an open environment to encourage participation and feedback. Furthermore, employees should be informed as to whom they should contact to report violations or ask questions. Companies should provide guidance to assist employees and agents on how to cope with and resolve difficult situations. Such counseling not only protects the person in the field, it also protect the company. Most importantly, compliance issues should not be limited to training classes and the compliance team. Corporate compliance should be stressed as an integral part of the company’s way of doing business. Undertaking due diligence is vital for ensuring that anti-corruption processes are efficient and effective. Due diligence reviews are also important for preventing potential harm to the firm’s reputation. It is important not to delegate substantial discretionary authority to individuals or subunits that the firm knows (through the exercise of due diligence) have a propensity to engage in corrupt acts. Additional ethical practices include formalized procedures or mechanisms for evaluating ethical and legal performance and for rewarding or punishing behavior. Examples include establishing a system for auditing and reporting legal-ethical violations, a formal ethics department for initiating, coordinating, and supervising a company’s anti-corruption process, and a crossfunctional committee for setting and assessing ethics policies and procedures. Motivating employees to behave legally and ethically can be prompted by the incorporation of ethics into selection, performance appraisal, discipline, and job analysis procedures. In addition, self-monitoring, monitoring of suppliers, and reports the board of directors are all good tools for ensuring that a compliance program is being followed. Moreover, from vetting new hires, agents, or business partners to assessing risks in international business dealings (e.g., mergers, acquisitions, or joint ventures), due diligence reviews can uncover questionable conduct and limit liability. It is also crucial that all of the elements of a company’s corporate compliance program receive the full support of upper management. If upper level management does not take efforts to combat corruption seriously, then neither will employees. The corporate compliance program must be enforced at all levels with a diversified firm. In instances of noncompliance, a company should take the necessary preventive steps to ensure that the questionable conduct does not recur in the future.

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The above elements of an organizational architecture are common to all firms that are active in eliminating corruption. However, firms differ themselves in the extent to which they emphasize each of these elements because of different organizational needs and different effectiveness of these elements in curing organization-specific illness. A compliance program therefore should be tailored to fit an individual firm’s needs and circumstances. Firms vary in their task and institutional pressures for corruption, susceptibility to corrupt environments, motives for corrupt practices, and malfeasant behaviors. In my view, a mad fox metaphor needs a structural surgery to effect a radical, thorough, and drastic cure seeking a permanent removal of the corruption disease. A wild puppy needs a specialized operation to heal a specific part (level of hierarchy, subunit, or location within an organization body) that is substantially contaminated by corrupt practices. A sick bulldog needs a decoupled injection that seeps throughout an organization body in order to treat unserious but whole bodyaffected malfeasance. Lastly, an errant rabbit needs a partial medication to alleviate some early-phase corruption symptoms plagued in a small part of an organization body. Corresponding to a mad fox metaphor’s system malfeasance, a structural surgery requires an entire company’s systematic efforts to obviate rampant illicit acts permeated throughout the whole firm. Regular codes of conduct, compliance programs, and control systems may not be sufficient to redress corporate illegalities for the mad fox. Instead, it necessitates a series of structural changes, including (1) dismissing ill-behaved board members, senior managers, and subunit executives; (2) restructuring the malfeasant subunits and replacing their leaderships; (3) formalizing and routinizing anti-corruption procedures, actions, and norms into everyday organizational activities; (4) linking ethics to personal consequences to fortify each employee’s compliance and encourage salience in each individual’s minds; and (5) establishing an anti-corruption office which initiates, mandates, coordinates, and supervises all corruption resistance activities. For a mad fox metaphor, it is especially essential that all elements of the anti-corruption programs receive the full support of upper management and the board of directors. More importantly, these programs must be enforced at all levels within the organization. It is important that codes of conduct be distributed

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to everyone in the firm and, if necessary, translated into the languages of foreign countries where the firm operates. To address a wild puppy metaphor’s categorical malfeasance, a specialized operation requires an area surgery which focuses on the treatment of a specific level of hierarchy, subunit, or location in which corruption is so severe and grave that the area accounts for a majority of the entire firm’s corruption. In this case, the firm can devote most of the anti-corruption resources to suppress corruption in the area. The firm may adopt promptimpacting approaches and take specialized stopgap measures to quickly correct wrongdoing in this area. These measures include (1) special training and educational seminars on resisting corruption for all employees in the area; (2) more specific legal and ethical training for senior managers in high-risk areas or functions such as sales, promotions, procurement, public relations, and international business; (3) change or rotation of senior managers in the area if these managers are involved in major illegalities; (4) formation of a special workforce or committee comprised of cross-functional managers in the area, role models from other areas, and officers specialized in business ethics and legal norms, in a bid to find an effective prescription; (5) enhancement of internal auditing, recording, and control over various activities conducted by the focal unit that are especially prone to corruption; (6) stringent disciplinary punishment for failure by anyone in the area to meet ethical expectations; and (7) requiring chief managers or directors in the area to bear or share responsibility for anti-corruption activities and tying their performance appraisal with the anti-corruption fulfillment in the area. To rectify a sick bulldog metaphor’s structural malfeasance, a decoupled injection is designed to curb system-wise corrupt practices using a series of anti-corruption policies and procedures that are standardized within a company and separated from its everyday workings. Unlike structural surgery that integrates anti-corruption policies and processes with other organizational policies and programs (e.g., human resource management), thus affecting the firm’s everyday decisions and actions, decoupled injection proceeds through an independent package of special rules, standards, norms, and procedures to be followed by all-level employees. The reason why this package is nonintegrated with other organizational programs and disconnected from the firm’s everyday actions is the fact that the sick bulldog’s corruption is

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not serve and its illness is at the early stage. Structural surgery may be too costly and excessive for this metaphor. Formalization and communication are especially essential to decoupled injection. Formalized rules on business ethics and conduct norms minimize leeway and opportunities that encourage corrupt acts by morally unconscious units and employees. Effective channels (e.g., memos, manuals, newsletters, and policy documents) should be established to communicate an ethics message to everyone. Singling out role models is another way of communicating explicitly what the anti-corruption efforts entail. Ethics-focused memos or newsletters may include articles highlighting recent actions undertaken by particular units or employees. These concrete examples increase the credibility of the firm’s decoupled policies, add an important texture to the definition of the organizational architecture, and communicate these policies in an accessible manner. Finally, to redress an errant rabbit metaphor’s procedural malfeasance, a partial medication is used to rectify a small scale of corrupt practices engaged by a small number of employees. Since these practices are sporadic, infant, and unserious, the errant rabbit metaphor particularly needs to sharpen employees’ awareness of the importance and procedure of resisting corruption. It is possible that some employees in this metaphor face a definitional problem with bribery, and thus need special guidelines clarifying differences between legitimate activities in cultivating interpersonal connections and illicit actions that deviate from legal, ethical, and moral norms. In particular, these guidelines should specify under what circumstances certain culturallyembedded practices such as gift-giving and entertainment are legitimate and what formalities (approval, signature, procedure, and etc.) should be conducted. Drawing the line between acceptable relationship-building and corruption practices is especially crucial for employees working in a sensitive area or location in which transactions depend largely on personal links. A company should take steps, including compliance rewards, responsibility sharing, and an auditing system, to ensure that these guidelines and related codes of conduct are strictly carried out. I must note, however, that ethical or compliance codes alone are not enough to combat company-level corruption due to several reasons. First, codes focus primarily on company processes and employee behavior. Understandably, the key objective of a code is to establish a company’s

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own business conduct standards. Companies do not consider themselves responsible for the behavior of those parties with whom they deal. It is up to each company to set and monitor standards for its own performance. This asymmetry between acceptance and giving policies suggests a less than full understanding of the most effective ethical strategy for deterring corruption. This becomes even more evident when a company must deal with outside business partners in a host country or from a third nation. For instance, it is difficult for a company to control a foreign supplier or subcontractor’s bribery of governmental officials. Second, code principles are not always binding on suppliers, vendors, and joint venture partners. Many executives, especially their country managers in developing countries, believe that their host country suppliers and vendors do not necessarily subscribe to the company’s anti-bribery provisions. Thus, the demand for agent and partner compliance needs to be more common for codes to be a significant factor in deterring corruption. Third, code effectiveness depends in large measure on whether or not they are introduced in an environment of trust. Absent a system that encourages employees to expose inappropriate conduct, codes will never achieve their full potential to deter wrongdoing. For most employees outside of the United States, for instance, the concept of whistle-blowing has a pejorative connotation or not much real meaning. For example, US operations in Western Europe report little employee use of the company’s “hotline” to report abusive practices. The picture is similar elsewhere and is sometimes complicated by other conditions such as the fear of reprisal and reported shortages of workplace telephones in certain regions. Lastly, firms need to strengthen code compliance verification procedures. Precatory words are insufficient weapons for effective action. Recognizing this principle, Shell has undertaken an initiative that relies on its code as a major tool in combating corruption. Shell country managers are required to certify that “neither the company nor its authorized representatives has been party to the offering, paying, or receiving of bribes” and that “no payments have been made which knowingly violate the laws of the country in which the company has operated.” Where such assurances are not possible, a discussion of the reasons why and a description of specific incidents must be noted. Follow-up reports that document actions taken are also required. After all, internal procedures that demand greater disclosure and accountability

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are key elements in a code’s rule-making authority. Corporate codes have a potentially vital role in the fight against corruption but, for the most part, firms have yet to acknowledge and to rise to the challenge of these new possibilities. Ultimately, global companies need to recognize that if they are serious about deterring corruption, a properly formulated, implemented, and monitored code is essential. To sum up, this section delineates an organizational architecture designed to fight corruption. This architecture, which aims to generate three intended results including education, detection, and deterrence, comprised of three interrelated components — culture, structure, and system. Culture addresses anti-corruption from a moral perspective while structure and system address anti-corruption from the power-related control and ethicsrelated compliance perspective, respectively. Because firms differ in task and institutional pressures for corruption, opportunity and motive for corruption, and intensity and hierarchical scales of corruption involvement, they require different metaphors that emphasize different treatments to rectify various illicit acts. I suggest that a mad fox metaphor needs a structural surgery to curb rampant corrupt practices permeated throughout the entire organization; a wild puppy needs a specialized operation to heal serious corruption diseases concentrated in a specific unit, area, or location; a sick bulldog needs a decoupled injection to cure its small-scale, early-phase, but all body-plagued corruption illness; and finally, an errant rabbit needs a partial medication to exterminate a small number of corrupt symptoms residing in a small part of a company.

7.13 PRACTICAL EXAMPLES Minicase 1: Corruption in Yuxi Cigarette From the taxman’s point of view, Chu Shijian, chairman of Yuxi Cigarette Factory and parent company Yunnan Hongta Group, might be the most important person in China — the company he heads forks over more to Beijing every year, by its own account, than any other in the country. What’s more, the 68-year-old chairman of Yuxi Cigarette Factory and parent company Yunnan Hongta Group has succeeded where other state

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bosses have failed: He’s proved that government-owned enterprises can thrive in the capitalist marketplace. What Chu has accomplished at Yuxi even has major foreign competitors worried. Says a Western tobacco executive, “We stand in awe of Yuxi’s ability to steamroller the market.” But in China’s volatile, corruption-fraught business climate, it’s virtually impossible to achieve Chu’s level of success without bending a few rules and making a few enemies. It looks as if one or the other has come back to haunt him: Late last year, his wife, Ma Jingfen, and his daughter, Chu Yingqun, were arrested on suspicion of corruption and imprisoned in Hunan. The plot thickened in November when Chu’s daughter died in prison — an apparent suicide. Since then, Beijing has installed its own people inside Yuxi Cigarette and has been pressing Chu to resign. So far, Chu remains stoically on the throne, surrounded by his associates, but the power struggle is not yet over. Chu’s story symbolizes the dilemma Beijing confronts when dealing with state-owned enterprises in the reform era. To compete in the marketplace, these firms need freedom — the right to conduct overseas trade independently, for example, and to diversify and juggle company assets. But when managers get these freedoms, they can amass not only money but power, and have ample opportunities to abuse it. The Yunnan case is probably more extreme than most. Yuxi has grown so big that it can practically give orders to the provincial government. It has even ventured into the off-limits zone of cross-straits relations, offering to sponsor a tennis tournament in Taiwan. “You really don’t have many state-owned enterprises like Yuxi that are immensely profitable,” says Eddy Zhang, a political analyst who writes for Window, a Hong Kong-based China-watching magazine. “On top of that, because of the nature of the industry, it has to be far away from Beijing.” Proof of Chu’s savvy is the empire he has built from a dodgy little rural factory. In 1979, when the party put him in charge of Yuxi Cigarette Factory about 110 kilometres from Yunnan’s capital, Kunming, the plant produced 300 000 cases of cigarettes a year — about 15 percent of them defective — and registered profits of less than 100 million renminbi (US$12 million). In fiscal 1994–1995, Yuxi’s profits hit 3.9 billion renminbi. Combined with Hongta Group’s three other factories, tobacco-related earnings topped 20 billion renminbi. “Chu Shijian has created a fairy tale in the tobacco business,” says a Hong Kong-based cigarette-equipment supplier.

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Yuxi is a pillar of the tobacco industry and tobacco taxes are a pillar of the national budget. Tobacco companies paid 71 billion renminbi to the central-government coffers in 1995, about 11 percent of the total, and more than any other industry. Yuxi Cigarette Factory alone reports it forked over 1.8 billion renminbi to Beijing last year. For Yunnan, tobacco is even more critical. Despite efforts to diversify the economy, tobacco generates roughly 85 percent of the province’s tax revenues. That makes Chu’s role there even more important. “The governor’s main job in Yunnan is to take care of Chu Shijian,” says a Chinese business consultant based in Beijing. “He signs the cheques.” In legend at least, Chu fulfills all the communist and capitalist prerequisites for China in the 1990s. According to the official company history, The Light of Yuxi (written with guidance from Chu himself), Chu came from a farming family in the destitute Yunnan county of Huaning and joined the People’s Liberation Army just before the Communist victory. He rose through the ranks and sailed into the membership of the Communist Party at the county level. Being branded a “rightist” (like most other upwardly mobile people of the day) in 1959, and later being rehabilitated burnished Chu’s image for the post-Mao era. Described as “the capitalist who supports socialist reform,” Chu evidently embodies all the virtues of both: “a hale and hearty spirit, indomitable character and extraordinarily elegant manner of speech.” Chu’s friends and business associates clearly regard him as a hometown boy with local interests at heart. They note, among other things, that he is “darkskinned” — implying rural origins — and speaks with such a heavy local accent that most of his business partners from elsewhere in China need an interpreter. But far from portraying Chu as a country bumpkin, associates describe him admiringly as an open-minded, straight-talking visionary. When travelling to tobacco-growing areas of the United States last year, for example, Chu was struck by the vast agricultural areas and straight roads. A travelling companion recalls that Chu gazed out the airplane window over the Midwest and announced: “We should learn from America.” Chu’s approach to the business has had a profound impact on Yunnan’s economy. He has invested heavily, for example, in cultivating the finest fluecured Virginia tobacco. For the past five years, he has plunged more than

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US$100 million annually in state-of-the-art technology, setting an example for Yunnan’s other factories. As a result, the province is now making a major value-added product, not just supplying tobacco leaf to China’s coastal areas. The improvements continue. Yuxi is building a 7-billion-renminbi factory equipped by top British, German, and Italian suppliers. The airy, sky-lit facility, where workers pad down broad aisles between gleaming new machines, is designed to be the single largest cigarette plant in the world. It will raise Yuxi’s capacity to a mind-boggling 125 billion cigarettes a year when completed in 1997. Yuxi stands to dominate the biggest smoking market in the world — 300 million people. Hundreds of brands, some throat-scouring varieties selling for less than one renminbi a pack, fight for fragments of that market. Yuxi’s main brand Hongtashan, or Red Pagoda — sells for 13 renminbi, more than imported Marlboros. Says the Western tobacco executive, “ They have the advantage in their own market, they make a very good product, and they have a very loyal customer base.” No wonder locals are loyal to Chu. The town of Yuxi, with about 100 000 residents, is virtually owned by the Yuxi Cigarette Factory. Among other things, the company has built 90 smart apartment blocks, towering office buildings, a new cinema, a modern stadium, a swimming pool, and a kindergarten. And since 1994, through the creation of the Yunnan Hongta Group — also chaired by Chu — Yuxi has diversified into everything from chemicals to real-estate development. These businesses, which are not taxed as heavily as tobacco, will also help keep Yunnan money in Yunnan. The way Chu has spent Yuxi’s money has earned him many friends in the county, in both high and low places. Two years ago, for instance, Yuxi invested in a power plant southwest of Kunming that will provide power to a phosphorous plant and cut-rate electricity to local residents. With money raised by selling shares of the plant to Hong Kong’s Shee Hing Trading and Japan’s Nissho Iwai trading company, Yuxi is building two more power plants on the same river. Chu enhanced his image this year, when the Hongta Group gave China Central Television one million renminbi to help set up 20 TV-broadcasting relay stations in poor areas, according to the Xinhua news agency. The idea

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is to provide educational programs for farmers to help them master advanced agricultural technology. “Yuxi is the only company that has supported the farmers, with new equipment and technology, and made a good relationship with them,” says the Hong Kong equipment supplier. So why is Chu in such hot water? Actually, it’s not clear just what he did to offend Beijing. Graft is rife in the Chinese business world, but friends and business associates insist Chu is clean. There could be an element of guilt by association: Chu’s wife, Ma Jingfen, has been detained for several months. Though no specific charge has been made public, associates say she and daughter Chu Yingqun are accused of using the tobacco boss’s influence to manipulate real-estate deals. The appearance of impropriety can be dangerous. In one incident, says a member of Chu’s delegation to the US last year, Chu was captured on film gambling in Atlantic City — a bad move for a Chinese government official. Yet, friends say Chu was merely mugging for the camera, and claim the picture is being used to frame him. Indeed, many observers believe that there’s more behind Beijing’s ire than meets the eye. The most plausible theory is that Beijing felt it was losing control of the Yunnan region to clannish local officials. In early 1995, Beijing removed provincial Party Secretary Pu Chaozu — a local with strong connections to Chu — and replaced him with Gao Yan, a progressive reformer from northeastern Jilin province. Under Gao’s guidance, Kunming Deputy Mayor Zhi Guorui has been appointed deputy to Chu, and is expected to take over the business after learning the ropes. Already, Zhi has appeared at conferences billing himself as chairman of the Hongta Group. Beijing has forced the company into line, at least on some of its activities. In December, for example, Beijing pressured Hongta Group to withdraw sponsorship of a tennis tournament in Taiwan that was to feature Michael Chang. The Hongtashan Tournament, due to be held in January, was canceled, irking Taiwanese officials. Sponsoring the tournament in the first place was a risky move given the rising tensions with Taiwan; it meant treading in the turbulent waters of cross-strait ties, normally the exclusive domain of Beijing bureaucrats. But Chu has made it clear that he won’t be removed easily. When Chinese public-security officials brought news that his daughter had

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committed suicide under police detention, the tobacco boss hardly blinked, associates say. He refused a chance to visit the Hunan prison where his wife and daughter were said to be held, instead staying on safer grounds at home. “He knew the situation was too unclear,” says a business associate in Yunnan. “It would have been too risky.” The same afternoon as that horrible news, a poker-faced Chu headed a previously scheduled board meeting at Yuxi. “He carried on as usual, as if nothing happened,” says a long-time business associate. “No one in the room knew, or could tell there was anything wrong.” Chu’s allies — many running businesses in tie-ups with Yuxi — are working overtime to ensure that Chu is not pushed aside. “The main thing now is the relationship between Gao and Chu, which at the moment is quite bad,” says a jittery real-estate developer with strong cologne and a thick Beijing accent. “But we’re working on it.” In one aborted effort, these friends invited a foreign journalist to interview Chu, hoping that the spotlight of publicity would protect him. Ultimately, the journalist was caught between two groups of provincial officials arguing over whether to grant access without higher approval. The upshot: no interview. More significant, says a source close to Chu’s office, is that the chairman has covered his backside by keeping track of the favors he’s done. When officials threatened to investigate for wrongdoing, Chu allegedly threatened to show reporters a safe full of notes from officials asking for shipments of Hongtashan Cigarettes, to be sold on at exorbitant profits. The papers would have exposed officials from Kunming to the Forbidden City, the source says. Whatever he has done, Chu is undeniably the brains behind a huge and increasingly complicated business. Replacing him with Zhi could spell disaster for the company, contends a Hong Kong source who deals with Chu regularly: “Chu is a real tobacco man,” he insists. “Zhi isn’t.” That leaves the government with a dilemma of its own making. Forcing Chu out might send the wrong message to state bosses — that success is dangerous. But leaving Chu in place may give a bad message too — that government bosses are above both the law and the central government. “Beijing can’t decide what to do with Chu,” says Chu’s business associate. “They don’t know whether to slap him down or use him.”

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Right now the odds favor a compromise — letting Chu remain in place for another 6–12 months, and putting him out to pasture with a hero’s farewell. But it’s hard to imagine the savvy tobacco king leaving the scene without a fight. Source: Adapted from Huus (1996).

Minicase 2: Rough Justice Corruption doesn’t come much more spectacular than a case in Woyang county, Anhui province, that the Legal Daily reported last December. The newspaper, published by the Ministry of Justice, related the case of a group of judges who decided to help a businessman friend of one of their number. The businessman was having a dispute with Duan Shiying, general manager of a trading company in Jilin province. The judges manufactured a case against Duan, fabricated a set of files and had him arrested. After six months they ordered his release — but only after his family and business associates had coughed up 240 000 renminbi (US$29 000). The judges split 200 000 renminbi among themselves; the rest went to the businessman. The judges, all Communist Party members, were later reprimanded, demoted or subjected to public criticism. But only one of them received punishment in court — a one-year suspended sentence. That’s just one example from numerous reports of corrupt judges that have appeared in the Chinese press, portraying a judiciary that perverts rather than enforces the law. China is building a legal system to support its evolving market economy, with several hundred new laws passed in recent years. But unless reform of the law is accompanied by reform of the judiciary, the rule of law is just as likely to become misrule. The government has made attempts at judicial reform. The 1995 Judges Law aims to raise the quality of judges by requiring that law graduates have at least two years of work experience before becoming judges. But it also provided a loophole by stating that those without the proper academic qualifications may become judges after undergoing a process of undefined “appraisal.” The new president of the Supreme People’s Court, Xiao Yang, has called for further reforms and for the media to supervise the judiciary.

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He has proposed a hotline and letter box for people to make complaints against judges. Despite this, evidence still abounds that China’s leaders don’t fully comprehend the importance of putting the rule of law in the hands of those qualified in law. In March, for instance, the government appointed Han Zhubin head of the Supreme People’s Procuratorate, or prosecutor’s office. In that job, he is the country’s top prosecutor, akin to US AttorneyGeneral Janet Reno. But Han, a former minister of railways, has no judicial experience at all. The corruption and incompetence of China’s judiciary stem from (among other problems) the poor training of judges, their meager wages, their low status and government interference in their decisions. But underlying all these is something more fundamental: the Chinese attitude that judges should be political instruments rather than skilled and impartial professionals. This attitude is rooted in the party’s history and ideology. When the Communist Party came to power in 1949, it declared that “law is a tool for the oppression of one class by another.” The party dismissed qualified judges and lawyers, whose professional training was deemed irrelevant. They were replaced by untrained cadres chosen on the basis of ideological purity and “good” class background. Many, perhaps most, of the 170 000 judges in China today have little education in the law. Those who have, sit on the top benches: The 100 or so judges who preside over the highest court in the land, the Supreme People’s Court, all have at least a bachelor’s degree in law. Many have master’s degrees, too, says Wang Yanbin, a judge in the top court. In the lower courts, however, a degree of any sort is a rarity. In fact, demobilized military men make up a high percentage of judges at the county level, where the majority of cases are heard. It’s hard to say what proportion of China’s judges are retired soldiers: The issue is controversial and few dare raise it in public. He Weifang, a law professor at Peking University, was one of the courageous few. In a January 2 article in Southern Weekend, a Guangzhoubased newspaper, He asked whether it was appropriate for military men with no legal training to be assigned to work as judges. Would anyone, he asked, assign military men with no medical training to work as doctors?

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The People’s Liberation Army (PLA) published a rejoinder in China Defence News. Why can’t retired army men join the law courts, it asked, pointing to the military’s contributions to the country. Under heavy pressure from the PLA, Southern Weekend published an apology, declaring that “the People’s Liberation Army [including demobilized soldiers at every historical juncture] has made major contributions at each stage of socialist construction.” Clearly, the PLA considers sterling socialist credentials sufficient qualification for the administration of justice. Indeed, some judges themselves appear not to understand concepts basic to being one. A China Youth Daily report in February provides an example of a judge — a president of a court in Shandong province — who seems to have been unaware of the limits of jurisdiction. Informed that he had no authority over an enterprise in another province, he declared that his power extended “to the heavens above and the earth below and the air in between.” And power, of course, corrupts, especially when it is combined with poor pay. A vice-president of the Supreme People’s Court is paid a little over 1000 renminbi a month; a lower-court judge earns 300–400 renminbi monthly. Called on to adjudicate cases involving millions of renminbi, judges are exposed to many opportunities for corruption. Some try to make opportunities for themselves. In cases involving business disputes, a court receives a percentage of the amount in dispute. So to drum up business, judges make “house calls” on enterprises to inquire about economic disputes. When they learn of one, they suggest legal action, offering their services and often implying a favorable court ruling. To maximize the court’s income, a judge may even ask a potential plaintiff to exaggerate the amount in dispute. Another widely reported problem is what the Chinese call “local protectionism.” Since judges are paid by the local government, their rulings often favor their paymaster. And woe to the judge who forgets this. “If a judge rules against the local government,” says a Beijing law professor who asked to remain anonymous, “the next day he will get a call from the municipal authorities saying one of the court buildings was constructed without the approval of the bureau of construction and will have to be torn down. There are many such cases.”

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The concept of judicial checks and balances also seems alien to the Chinese judiciary. Just as Chinese officials are loath to make decisions without consulting their bosses, so, too, judges regularly ask their superiors for “guidance.” The result, says He of Peking University, is “to make the appeal process meaningless, since the higher court is unlikely to overturn the original verdict, which it participated in making.” Source: Adapted from Ching (1998).

Minicase 3: Bitter Pill: GlaxoSmithKline in China “GSK shares the desire of the Chinese authorities to root out corruption.” So declared GlaxoSmithKline, a British drugs giant, this week as it struggled to respond to a scandal in China. Four executives, all Chinese nationals, have been arrested on accusations of, among other things, paying nearly $500 million in bribes to doctors and officials to boost sales of the firm’s treatments. Chinese state television broadcast an interview in which one of the arrested executives gave details of the alleged bribery scheme. Another executive, who is British, has been told not to leave China. GSK said it would co-operate with the investigation. Scandals involving the marketing of medicines are not just a Chinese phenomenon. Big Pharma’s business model for peddling its pricey pills, which includes inducements such as “educational” conferences at lavish resorts, has led to abuses even in countries with well-paid doctors and a strong rule of law. A year ago America’s Justice Department announced a $3 billion settlement with GSK, after prosecutors had accused the firm of illegal promotion of its drugs. In China, however, that seed falls on fertile soil. For a start, doctors are woefully underpaid. And perverse incentives in China’s official policies, says a report from the World Health Organization, let hospitals and doctors make money from selling medicines. Never mind if patients really need all those pills. The chief investigator in the GSK case, Gao Feng, said this week he was looking into other foreign drug firms’ activities but was not yet sure they had done anything illegal.

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Corruption is pervasive in other areas of Chinese corporate life. A local expert who investigates wrongdoing in business insists it has got worse in recent years, as fraud schemes have got “tighter, smarter and bolder.” Multinationals that have put local Chinese managers in charge of their operations in the country are often the most vulnerable to jiggery-pokery. While sales are booming, the top brass at headquarters are happy to give local managers a free hand. Sometimes they may suspect murky dealings, but are reluctant to appear ignorant of Chinese cultural traditions such as guanxi. As a result, they are failing to mind the store. Transparency International (TI), an NGO that tracks corruption trends, ranks China 80th out of 176 countries in its latest corruption-perceptions index. That middling ranking, which reflects how outsiders perceive levels of corruption, is bad enough. But to get a true sense of how bad things are, it is better to ask locals, as TI also does in many countries. However, when it tried to persuade Chinese market-research groups to conduct surveys, none would accept the job. The researchers deemed the very questions too “sensitive” to ask. China’s new leaders acknowledge the seriousness of the problem, and say they are making a priority of tackling corruption. But well-intentioned central directives often fail to achieve much. Local bureaucrats typically respond to them by doing whatever it takes, at the least trouble to themselves, to give the appearance of meeting their quotas. A good example is how officials responded to a recent suspected fiddle involving foreign trade. A few months ago there was a surge in the monetary value of exports from Shenzhen, a region with a huge electronics industry, even though the numbers of containers being shipped remained flat. Unless iPads had been replaced by gold bars, it seemed that some exporters were colluding with banks and shipping firms to inflate invoices. The aim was to make money illegally by arbitraging the different rates offered for the yuan inside and outside China. Official investigators pounced. But unable or unwilling to find and jail the actual crooks, says an industry source, officials have instead been strong-arming innocent shipping firms. These are now being squeezed to under-invoice future shipments from Shenzhen, and to claim instead that goods are leaving from other ports. Why? Because then the trade figures

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would show superiors in Beijing that the local investigators had “solved” the problem of invoice-faking in Shenzhen. When looking for easy targets to fulfil their quotas of corruption-bashing, local officials may find it simpler to pick on foreign firms than on local ones that have good connections with local or national politicians. For its part, the central government has rejected suggestions that, in the case of GSK among others, it was singling out foreign multinationals for punishment while letting domestic firms continue corrupt practices. Nevertheless, it does give the news media — all strictly state-controlled — free rein to do some foreigner-bashing from time to time. GSK’s legal problems, however they turn out, are evidently not a simple case of foreigner-bashing. But unless the authorities become just as strict with domestic firms, little progress will be made in stamping out corruption in business. Assuming China’s new leaders are sincere in wanting this, the task they face is enormous. Source: Adapted from The Economist (2013).

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8 PRACTICAL GUIDELINES TO GUANXI CULTIVATION

Knowing how to construct, maintain, and reinforce guanxi relations is imperative for any businesses in China. This knowledge has a favorable impact on both effectiveness and efficiency of operations. It also affects a firm’s long-term growth. This chapter aims to provide practical guidelines to companies operating in China with respect to properly cultivating guanxi connections. This chapter lists eight suggestions: (1) constructing your own network; (2) utilizing intermediaries; (3) searching for the right people; (4) transforming individual guanxi into organizations; (5) hiring locals and dispatching ethnic Chinese; (6) monitoring guanxi within an organization; (7) maintaining guanxi relations; and (8) improving credibility. Practical examples are offered at the end of this chapter.

8.1 CONSTRUCTING YOUR OWN GUANXI NETWORK Many Chinese have developed extremely sophisticated skills that facilitate the development of interpersonal relationships. Shared attributes and affiliations are fundamental to the process. In Chinese society, people use the bonds of shared kinship, locality, work place, or school to make friendly contracts. These shared affiliations can be quite flexible. A shared locality, for example, may be a village, a county, a city, a province, a geographic region, or even an entire country. Shared circumstances, attributes or affiliations are important, so the more attributes an individual has, the more mianzi he will enjoy, and the more guanxi he can construct.

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It is clear that the China market cannot be tackled effectively today without paying due attention to the construction and maintenance of good guanxi. Business transactions with Chinese individuals and organizations need to be approached with the knowledge that the Chinese will place them in the context of their own guanxi networks, which may require meeting obligations to individuals who have no direct involvement in the matter on hand. In China’s collectivist culture, the “real” decision-maker may be the network as a whole, not some mysterious and unseen individual. It is suggested that Western investors and marketers need to establish guanxi of their own, which requires looking beyond the transaction at hand to its implications for the development of personal relationships. In general, a businessperson can demonstrate the good faith that forms the basis for a gradual transition from outsider to insider by bestowing favors and “face” through considerate and sensitive giving of minor gifts, hosting appropriate dinners, and more importantly, giving personal attention. For new foreign investors in this context, entry mode is deemed to be associated with guanxi. A good local partner in the joint venture model can spur the foreign venture’s market expansion and enhance its market power against rivals in the host environment because of the operational synergy effect between a local partner’s existing guanxi network and a foreign partner’s technological and organizational competencies. When early investors have not yet built their own guanxi, local partners can greatly assist their ventures in reducing contextual or transactional risks by using their country-specific knowledge such as guanxi construction. Understanding the crucial role of guanxi in affecting all major dimensions of firm performance and knowing the ways of creating and maintaining a guanxi network are quite necessary in gaining an edge over competitors and thus influencing corporate success. All Chinese entrepreneurs, managers, and bureaucrats prefer to do business with people with whom they feel close. It is essential for foreign businesses to spend time in establishing personal relationships in a proper manner. By day, local business people run their business. By night, they do the real work — entertaining contacts in order to build guanxi that will engender the understanding, flexibility, and trust necessary to make

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business deals work. Such evening gatherings are an ideal opportunity for foreign business people to construct guanxi with local businessmen and government officials. Results will certainly turn out better if the foreign businessman hosts a good dinner. More importantly, there are a variety of ways to do favors other than dinner and entertainment. For instance, assistance in the education of a client’s children, household appliance or cosmetics purchases, or having a holiday tour together are among the options. It is clear that foreign marketers and investors who have maintained good guanxi with local suppliers, buyers, partners, and government authorities have a competitive edge over those who have not, in the smooth running of routine business operations, in securing information about government policies, and in securing various administrative approvals. The “visiting abroad” invitation may be the most effective and immediate means to build guanxi with the person you invited. It is reported that many Chinese managers and government officials have had too many dinners hosted by foreign businesses to remember who is who. Through an invitation for an on-site visit, the company’s technological competencies and organizational skills may be strongly impressed on the Chinese manager or official’s memory. Of course, one of the most immediate benefits gained from the invitation is that you have established a new guanxi with a key executive or official. Although more or less costly, this can engender competitive advantages over rivals and generate sustained economic rent in the long run for the firm. Existing guanxi can also be used as a resource to attract and maintain more guanxi. The ability to help others is enhanced considerably if one grants a favor to one person by asking the same favor of another who is in a better position to obtain the necessary service. This causes guanxi to become a social resource in addition to one’s occupation, social position, and material possessions. Yang (1994) argues that if in capitalist systems “the rich get richer,” it can be said that in China today, the more guanxi one has, the more one can maneuver in society. Deploying guanxi becomes “the weapons of the weak” (Scott, 1985). One’s independence in everyday affairs is gained paradoxically through a dependence on social relations (Yang, 1994).

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8.2 UTILIZING INTERMEDIARIES The use of appropriate intermediaries can broaden one’s guanxi network. The intermediary is often a friend who is familiar with the other person, and who implicitly vouches for one’s virtue and reliability to the other person. A general principle in long chains of guanxi involving intermediaries is that such chains are composed of a series of dyadic relations in which each person will help the next person in the chain because of their direct personal relationship; and not necessarily with the intention of helping the stranger who made the original request. As guanxi works through channels of familiarity, introductions by an intermediary are often more effective than self-initiated acquaintance. In many cases, the person who performs the last favor in the chain of favors will not know and will never meet the originator of the request. An intermediary may also act as a scout for his or her friend in cases in which the guanxi between two potential guanxi transactors is not sufficiently strong or secure. A go-between who has better personal ties with the guanxi target, say an official, may inquire into how responsive the official might be to guanxi overtures from his friend, what kind of gifts are most likely to win him over, or whether the position and jurisdiction of the official would enable him to fulfill the particular request. Foreign investors can use altercasting to build up their guanxi in the beginning. Altercasting refers to the establishment of guanxi between two individuals who have no ascribed commonality. An effective way of attaining this goal is to use an intermediary who is a mutual friend of both parties. The intermediary can vouch for the behavior and sincerity of either party. A personal reference from a respected member of the Chinese business community may be the most important strategy in launching a new business in China. Recently, many of these intermediaries are ethnic Chinese who have been educated abroad and who have a good knowledge of both Chinese and Western cultures. Indeed, part of the art involved in guanxi is in knowing that one gets one’s way not by observing formal and bureaucratic regulations or by going through proper channels, but by creatively seeking out unofficial routes, detours, and shortcuts to get around the officially recognized ways of doing things.

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In guanxi chains, indebtedness is embedded within each specific link or dyadic relationship, not diffused all along the chain. Each person in the chain will only be indebted to the next person to whom she or he made a request. In this way a person may, through the guanxi of guanxi, transcend his or her own limited social network and cross over into several others without incurring an exorbitant debt to everyone involved. Intermediaries are often unaware that they are links in a chain of personally transferred requests. They may think that they are simply helping the person who approaches them when in fact their kindness will ultimately benefit a stranger.

8.3 SEARCHING FOR THE RIGHT PEOPLE It is neither realistic nor necessary to build guanxi with everybody in the partner organization and government agencies. The selection of the right person in the course of guanxi construction is therefore crucial to the sustained effectiveness and efficiency of guanxi. In searching for the right person at the top level, a foreign business needs to find who has the dominant power in controlling the firm, and has better relationships with local authorities. A puzzle that foreign businesses often face is the power difference between the general manager and the secretary of the communist party (shu ji ) in the firm. In general, shu ji may not interfere with the firm’s routine operations, except for strategic decisions such as large investment projects. The role he actually plays can be judged from three aspects simultaneously: his influence in the firm, his relations with government officials, and the political climate in the country. Apparently, the shu ji’s power is greater if his internal influence is bigger, his relations with authorities is better, and the nation’s political climate is grimmer. If the shu ji and the general manager (who could be same person in some firms) get along well with each other, then building guanxi with both is helpful. If not, the foreign business must invest in the one with greater power, and at the same time, maintain a relationship with the other at an acceptable level. Also, building good relations with deputy general managers in charge of production, marketing, and finance are an essential element of relationship construction.

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Furthermore, although they do not have authority to make final decisions, functional-level managers usually have a great influence on top management decisions. Foreign businesses new to the local firm can create guanxi with the partners starting with functional-level managers. In many large state-owned enterprises, mid-level managers have authority to make decisions involving small size investment projects and regular import and export deals. Among different levels of managers, top-level ones should generally be treated as a priority for guanxi construction. Another major type of guanxi building lies in the relationship with government officials. Foreign businesses often feel perplexed when they deal with bureaucrats at various levels. Several suggestions on the issue are provided as follows. First, it must be known that any business in any industry in China is subject to dual governmental controls: one by a provincial government or its agent in the region and the other by a corresponding national ministry or its agent in the region. If a project is of strategic importance to the national economy, foreign businesses will also confront intervention from central government agencies (e.g., SEC, SPC, MOFTEC). It is necessary to first have an overall picture concerning what government institutions, at both the central and local levels, are involved with the project or deal and which one of them will make the ultimate decision. Second, the mobility of political figures must be taken into account. When a political figure in power, your guanxi, leaves an institution, that will be when you lose your good relationship with that institution. Therefore, relying solely on one official in important governmental institutions is not a proper guanxi construction strategy from a long-term perspective. Third, a foreign business can find the right toplevel person in the institution by contacting or consulting with low-level officials in the institution or those in other government institutions. The person the firm searches for must be the one who makes final decisions, or at least plays a crucial role in the decision-making process. The head of an institution, or a department in the institution, may not necessarily be the most powerful person in the corresponding unit. The power in this circumstance largely depends on his guanxi with key people in higher authority.

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8.4 IMPLANTING INDIVIDUAL GUANXI INTO ORGANIZATIONS The relationship between individual guanxi and organizational guanxi is analogous to that between individual learning and organizational learning. Organizations learn only through their members. Organizational guanxi has to be based on individual guanxi. All business activities are initiated and implemented by individuals. If a staff member’s knowledge is not recorded in organizational memory, the organization will lose that knowledge once the member leaves the organization. When employees leave an organization and take with them their valuable guanxi, the organization suffers. Therefore, companies should design a strategy to successfully transform individual guanxi into organizational guanxi. For instance, whenever a company employs a local staff member who possesses some valuable guanxi with, say, a key official of an important government authority, top managers in this company should try to get involved in the guanxi network with that government official. This is often achieved through social activities initiated by that local staff but financially supported by the company. Organizational guanxi will be substantially strengthened by numerous individual guanxi maintained by internal employees. Companies, whether local or foreign, should realize the paramount value of such human capital and social assets.

8.5 HIRING LOCALS AND DISPATCHING ETHNIC CHINESE There is no doubt that many Western companies have successfully built their own guanxi in China. Due to cultural and language barriers, however, foreigners are often at a disadvantage in building and developing guanxi in China, in comparison with local or ethnic Chinese. In other words, the liability of foreignness propels the costs of guanxi construction and difficulties of guanxi cultivation. Amongst these difficulties, language is a fundamental hurdle. To express oneself in Chinese, especially in Mandarin, is a necessary, if not a sufficient, condition for developing one’s own guanxi. Hiring local people who possess both necessary skills and useful guanxi helps the company to fulfill the need of organizational guanxi.

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In this process, companies should not consider hiring those people who claim nothing but guanxi. In general, they are less trustworthy and short of specialized expertise. Moreover, companies should integrate the need for guanxi with different departments within companies. This means that in recruiting employees for different positions, varying levels of importance are attached to their existing guanxi connections and their capabilities to construct new guanxi relations. For instance, a new marketing manager must have a much more intensive and extensive guanxi network than that of a new engineer. Furthermore, a company should take into account what guanxi the candidate has and whether this guanxi is what the company needs. For example, a financial manager candidate who possesses guanxi with bank officials in charge of loans or foreign exchange administration is certainly more ideal than another candidate who has guanxi with a supplier. In addition, local managers may bring a series of specific benefits relating to guanxi. For example, they may handle the tax authorities, government issues at every level, and contacts for product distribution. It is also advisable to employ those local Chinese who indeed have guanxi connections that the company badly needs despite a lack of necessary expertise as an agent, advisor, or consultant. Hiring these people as full-time employees is often not appropriate because other staff might not cooperate if they know the underlying reasons for their employment. Further, if the company ultimately wants to fire those people, their guanxi contacts may work against the dismissal. It has been reported recently that foreign companies employ many children, and perhaps grandchildren, of the central leaders in Beijing as advisors. Dispatching ethnic Chinese, particularly young MBAs, to work in China is another recommended solution for foreign companies to build up quick but effective guanxi connections. Foreign companies can take advantage of their existing guanxi networks in China, their ability to cultivate new guanxi relations, and lower dispatching costs relative to foreign expatriates. The presence of expatriates in China is an imperative for building the firm’s own guanxi network. Regular visiting and meeting with customers is essential in creating and maintaining long-term guanxi with them. American companies often lose their deals in the final stage of transactions, due in large part to the failure of regular visiting between local agents and customers.

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This failure makes the local agents and end users assume that you are not serious about doing business and maintaining guanxi with them. Therefore, if you want a real stake in the local market, it is helpful to station expatriates there. Foreign marketing personnel are needed to establish longterm guanxi with customers. Foreign engineering expertise is needed for after-sale service and to provide the latest engineering know-how, which not only enables production to keep pace with international competition but also acts as a big favor to the local partners and governmental agencies, because technology is the most badly needed production factor in the country. In other words, the presence of expatriate sales personnel and engineers not only provides for excellent guanxi with local customers, but also provides ready know-how to quickly adjust products and prices to market demands.

8.6 MONITORING GUANXI WITHIN AN ORGANIZATION Monitoring guanxi within an organization includes (1) maximizing guanxi benefits by transferring guanxi from one operation to other operations; (2) auditing guanxi with the firm’s outside stakeholders; and (3) mapping guanxi demand with guanxi supply on a regular basis. If a company has various units in China (subsidiaries, branches, representative offices, joint ventures, etc.), the company should consolidate and coordinate the need of guanxi as well as the stock of guanxi within a diversified network. When the guanxi a unit maintains would also benefit other units, the company should take measures to extend the guanxi to these units. Auditing guanxi with outside stakeholders such as customers, suppliers, and government authorities enables the firm to analyze the progress that it has made in cultivating and applying guanxi and to identify the strengths and weaknesses of the current guanxi network. In so doing, the firm should identify what individual guanxi has been transformed into solid and sustained organizational guanxi. Amongst individual guanxi, the firm may further differentiate into four types: (1) strong individual blood guanxi (e.g., core family members); (2) weak individual blood guanxi (clan members); (3) strong individual social guanxi (e.g., classmates); and (4) weak individual social guanxi (a classmate’s friend). The identification of these groups may

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help the management realize the sustainability of organizational guanxi and the related competitive edge derived from such guanxi. Different organizations have idiosyncratic needs for guanxi networks. Since guanxi construction is a costly social investment, firms should evaluate periodically whether the existing guanxi network is sufficient for operational needs. This in turn helps top managers decide if the company should develop new guanxi connections. Like any investment, guanxi is launched according to needs. While the economic value of guanxi cannot be disputed, many do not see its liabilities. Indeed, guanxi may be seen as a double-entry system (asset as well as liability), a continued exchange of favors between the two parties. When one party receives a favor from the other, it is expected that the former will reciprocate at an unspecified time in the future. Without this reciprocity, guanxi cannot be sustained. The reciprocity is morally binding and is associated with elements of trust and credibility. Thus, whenever a favor is obtained by means of guanxi, an entry should be made on the liability side (i.e., payables) as well as on the asset side.

8.7 MAINTAINING GUANXI RELATIONS The maintenance of close guanxi requires continual social interaction. Social visits, invitations to dinner, and gift-giving facilitate this process. Without it, guanxi becomes distant and may gradually wither. One technique to ensure continual social interaction is to add more bases to the guanxi. Multiplex guanxi relations increase the opportunities for interaction. They also increase the feelings of commonality between parties and make it easier for guanxi to develop. Multiple guanxi are also closer and more consolidated than single-strand guanxi. Mutual rendering of help is crucial to the maintenance of guanxi, though it need not be equally beneficial to both parties. Extension of help may be unidirectional. But guanxi can still be maintained so long as the resource allocator does not suffer too much cost and feels that he can depend on the petitioner to return the favors in time of need. This assurance of dependability is crucial to the maintenance of guanxi. Reliability varies with the closeness of the guanxi. The closer the guanxi, the higher is the expectation of its

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reliability by both parties and vice versa. The value of guanxi does not exclude cost considerations. The following example illustrates this: If three people offer you something at the same price, you will choose to work with the one whom you have guanxi with. If there is a vast difference, say a 20–30 percent difference, then guanxi does not make much difference. But if the difference in price is small, then you will have to investigate. If the cheaper supplier going to give you inferior quality later? Cheat you later? You may even want to go and ask the supplier you know, “Why is your price higher than the others? Can you lower the price?” You ask him because you prefer to work with the person whom you know better. You feel sure that he will not cheat you.

Maintaining guanxi also depends on an ongoing demonstration of reliability and trustworthiness. Unreliability will transform a close guanxi into a distant one faster than any other factor. The consideration of guanxi in business fills the gap left by proponents of the market perspective which had largely ignored economic actions embedded in social relations. Once a guanxi has been established, and time and effort are invested to develop the relation, there is a great reluctance to let go of the association even when there may be objective reasons to do so. Continuous reinforcement of personal attachment for guanxi relations is also necessary. Guanxi relations that are premised exclusively on material benefits are fragile. To maintain guanxi connections, it is important to reinforce personal relationship with the partner that cannot be readily imitated by others. Personal implies something specific to the two parties in the relationship such as sharing inner feelings and family gathering. Sincerity and frankness are essential. To do this, one must acquire an in-depth knowledge of the partner’s personal needs and demands.

8.8 IMPROVING CREDIBILITY Like guanxi, kexin is not static; it can deteriorate. Once credibility is established, its maintenance is dependent on good work performance

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and the perseverance of a person in honoring his word. If he does not keep his word or cheats, he forfeits his kexin. As kexin operates on social sanctions and personal trust is embedded in webs of interpersonal relationships, the obligations inherent in these interlocks will discourage malfeasance. Nevertheless, as guanxi is a system in which both parties are mutually understanding and flexible, compromises between parties can be made. The outcome of one’s credibility after a violation of trust also depends on the quality of guanxi. The closer the guanxi, the higher are the chances of a misdeed being forgiven or dismissed as a mistake. Existing power relations also influence the outcome. The resources that one possesses or has access to affect the responses of others to a transgression. In general, kexin is more relevant for those who know each other very well. Without strong and supportive guanxi, even a small transgression can destroy one’s kexin. Personal trust possesses more than just an economic value. In conclusion, guanxi seems to be the lifeblood of the Chinese business community, extending into politics and society. In the Chinese context, although the government has enacted thousands of laws, rules, and regulations, almost none are completely enforced since personal interpretations are often used in lieu of legal interpretations. Therefore, guanxi ties appear to be very helpful in dealing with Chinese bureaucracy. Rather than depending on an abstract notion of impartial justice, the Chinese people traditionally prefer to rely on their contacts with those in power to get things done. A practical consequence of guanxi is that personal connections and loyalties are often more important than organizational affiliations or legal standards. For instance, whenever scarce resources exist, guanxi rather than bureaucratic rules mainly allocate resources. In essence, while the Chinese bureaucracy often inhibits action, guanxi facilitates action. Guanxi provides a balance to the cumbersome Chinese bureaucracy by giving individuals a way to circumvent rules through the activation of personal relations. Developing, cultivating, and expanding one’s guanxi has become a common preoccupation and a form of social investment in China. Figure 8.1 schematically illustrates the above suggestions.

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Practical Guidelines to Guanxi Cultivation   301 Use Individual Guanxi for Firms

Hire Locals

Construct Your Own Guanxi

Utilize Intermediaries

Search for the Right People

Improve Credibility

Offer Favors

Legitimate and Ethical Guanxi

Dispatch Ethnic Chinese

Monitor Guanxi

Maintain Guanxi

Figure 8.1. How to develop legitimate guanxi.

8.9 PRACTICAL EXAMPLES Minicase 1: GM in Shanghai On 25 March 1997, General Motors, the world’s largest auto maker, entered into a contract with Shanghai Automotive Industry Corp. (SAIC), a Chinese stateowned auto manufacturer, to set up a US$1.57 billion automotive company in Shanghai. The joint venture, headquartered in the Pudong New Area of Shanghai, included two corporations: Shanghai GM (SGM) for the manufacturing, sales and distribution of vehicles and Pan Asia Technical Automotive Center (PATAC) for the development of vehicle design and engineering. Shanghai GM focused on building midsize sedans. It has a vehicle assembly plant, a stamping plant, a V6 engine plant, an automatic transmission machining and assembly plant, and vehicle marketing and distribution operations. The assembly plant is targeted to manufacture 100 000 vehicles annually. PATAC is the first joint venture automotive development center in China. It acted as the technology integrator for vehicle design and development for the joint venture.

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Prior to this joint venture, both GM and SAIC had international joint venture experience in China. In 1992, GM teamed up with Jinbei Automotive, a company owned by a Shenyang entrepreneur, in manufacturing pickups. This joint venture turned out to be a disaster for GM. A state company later absorbed Jinbei Automotive and production was put on hold. On the other side, SAIC entered into a joint venture with Volkswagen (ShanghaiVolkswagen) manufacturing a model called Santana. Though sales of the company was reported to be good, the number of vehicles it had produced was only 9.6 percent of China’s total vehicle production in 1994. It appeared that both companies were not able to achieve their strategic goals through those joint ventures. As a result, the Detroit auto giant finally collaborated with China’s number one passenger-car maker to continue its work in China. In 1995, a base agreement was signed between GM and SAIC. The joint venture was highly encouraged by both governments. The US VicePresident Albert Gore, Jr., and China’s Premier Li Peng attended the March 1997 signing ceremony. It appeared that this joint venture had an excellent mix in skills, knowledge, and resources. Compatible goals: Similar to many other joint ventures, GM and SAIC had their own strategic goals that they would like to achieve through the joint venture. In this new relationship, their goals were very similar to each other’s in both global and local terms. Globally speaking, at the beginning of the 1990s, GM noticed that the Asia-Pacific region was the fastest-growing consumer market in the world. In order to compete with its Japanese competitors, GM realized that it had to set up a network in the region. It started plants in Taiwan, Indonesia, and Thailand. The open-door policy of the Chinese government had made it an attractive site for GM to complete its network. The open-door policy for China’s auto industry was one of the ways that China could expedite the development of its auto industry through learning from technologically advanced countries. The government hopes that one day China can build its own world-class vehicles and become the auto center for its region. Besides, the change in political climate has made China eager to import more from the US and less from Japan. Therefore, in terms of global goals, both GM and SAIC had the same target market and competitors.

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Locally speaking, the open-door policy has attracted a lot of foreign investors to China. It has resulted in an emerging middle class. The demand for vehicles, especially family cars, increased drastically. Both GM and Chinese government realized that the Chinese market has a large pool of potential buyers. From GM’s point of view, setting up a joint venture with a local company is the better way to get access to the market. From the Chinese government’s point of view, in order to develop its auto industry and to prevent a large outflow of resources, teaming up with GM appeared to be a reasonable solution. Therefore, locally speaking, capturing the growing market in China became the common goal of both companies. Complementary skills: Shanghai is one of the major cities in China. It is a center for all major business activities. As the number one passengercar manufacturer, SAIC has established a scale of economy in sedan manufacturing and component supply systems. In addition, SAIC has a welldeveloped network in dealing with the local government, distributing finished cars, and finding suitable workers for the company. SAIC, as a new partner, could help GM minimize transaction costs. SAIC’s knowledge, experience, and network in China’s auto market provided the best local support for GM. In order to gain approval from the Chinese government in joint venturing with SAIC, GM had positioned itself by investing millions of dollars into parts joint ventures and licensing agreements in China. On the technology side, it established two GM–China Technology Institutes to teach Chinese college graduates to design car parts, engines, and transmissions. It also brought Chinese engineers to Detroit to teach them computer-aided design and other aspects of vehicle development. Through these activities, GM used its advanced technology to impress the Chinese officials. It even invited Chinese officials to visit its Brazilian plant. The Chinese officials were impressed by GM’s global network that allowed the plant to produce cars designed in GM technical centers around the world. This visit became a key factor for the Chinese government to award GM with the SAIC contract. In addition, during the negotiation, GM agreed to set up the PATAC and coordinated research projects with various Chinese universities. GM’s contribution in technology will allow China to further develop its automotive industry to a world-class level.

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Commensurate risk: The failure with Jinbei Automotive had taught GM a good lesson in selecting a local partner in China. SAIC, a profitable and well-established state-owned automotive manufacturer, would provide GM a minimum level of risk in management and finance. As China’s number one passenger-car manufacturer and a 10-year partner with Volkswagen, SAIC’s expertise in the industry and experience in working with foreign partners would allow the new joint venture a higher level of understanding in strategic planning. Furthermore, the Chinese government’s policies in liberalizing its auto industry, and the “buy American products” campaign started in 1992, had provided a favorable environment for the joint venture. From SAIC’s point of view, partnering with GM will allow SAIC access of GM’s advanced technology, management system, and global network. In fact, GM is probably the only company in the automotive world with the resources to work with SAIC on an across-the-board basis. Cooperative culture: As a company in Shanghai, SAIC had a lot of business opportunities to deal with foreign companies. Its joint venture with Volkswagen had allowed it exposure to non-Chinese operation systems. Contrary to Jinbei’s chairman, a self-styled entrepreneur who balked at taking advice from GM’s management, SAIC follows the government policies of learning from the American corporations and therefore cooperation will not be a problem in the new joint venture. Similar to SAIC, GM had a joint venture with another Chinese corporation before. It provided an opportunity for GM to learn the tricks in Sino-Western joint ventures. Furthermore, GM had joint ventures in other developing countries. Its experience would help it to deal with the Chinese partner. Besides, the two-year negotiation period had allowed them to get familiar with each other and lay out details of the joint venture. The detailed strategic planning would enable both parties to work according to the plan that would then avoid conflict and develop a higher trust level. Commitment: The Shanghai–GM joint venture was not only a partnership between GM and SAIC, it was also an economical partnership between the US and China. The presence of US Vice-President Albert Gore and China’s Premier Li Peng at the signing ceremony had reflected the importance of

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the new joint venture. It implied that both governments guaranteed the commitment of both parties to the new company. The formation of the new joint venture resulted primarily from the commitment GM had made to China’s automotive industry. Academically, GM coordinated research projects in various Chinese universities, and it also set up technological institutes as mentioned earlier. Technologically, GM transferred some major skills to the new joint venture which allowed China to build world-class level vehicles. GM’s commitment to include China as part of its global network played a major role in the new joint venture. Financially, the 50/50 share of the US$1.57 billion investment to the joint venture further demonstrated the commitment of both companies. Capability: The capabilities of the firms affected the profitability and stability of the joint venture. In terms of strategic attributes, SAIC provided strong local support to the joint venture while GM contributed technology and global support to the new company. Their strengths in strategic attributes determined the structuring of the company. GM’s advanced technology, global network, and international management skills served as the backbone of the new joint venture. On the other hand, SAIC’s familiarity with the local market was a key factor in marketing the new products and competing with other joint ventures in China. The sound financial and sales records of both companies ensured a good start for the joint venture. The 50/50 equity contribution indicated that both partners had a similar level of bargaining power. In conclusion, the joint venture had made GM the second major investor in China. The influence of GM in China’s automotive industry will be greatly enhanced by this joint venture. It would also better position GM to compete with Japanese auto makers and become the major auto supplier in the Asia Pacific market. On China’s side, the joint venture will bring its auto industry to a higher level and eventually position China as the linchpin for the Asia-Pacific region.

Minicase 2: Solving Staffing Problems Staffing of joint venture projects in China is a major headache for international chemical companies. Some firms such as Henkel say staffing is one of the

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major bottlenecks to expansion in China. Companies are looking for help in this area and ways to better understand guanxi, the system of business relationships, and lianxi , the network of contacts — both of which are often a mystery to foreigners. Few Chinese nationals have the requisite technical and language skills to work at a senior level in a chemical joint venture. Most ventures are led by a US or European executive who is reported to directly by other Western, or Hong Kong or Taiwanese-born, Chinese-speaking staff. Sometimes there may still be problems in dealing with Chinese joint venture partners. However, many chemical companies, especially those in the US, have an untapped resource in China-born, Western-educated staff, many of whom work in R&D. When Hercules was considering entering the Chinese market, it set up an advisory council of its two dozen China-born employees to discuss proposed projects and help provide local contacts. One member of that council, Henry Mei, is now general manager of the company’s first joint venture in China — Shanghai Hercules Chemicals, a paper chemicals maker — with Shanghai Chlor-Alkali Chemicals. He reports to Hercules China President Dean Lee, who was also born in China and has had extensive experience there, and was able to provide considerable insight into the Chinese market. Mei says China-born managers have several advantages over those from Hong Kong, Taiwan, or Singapore. “As a Shanghai native, I speak the local dialect — and also the local slang,” Mei says. “That tends to make Chinese people more comfortable — then they will tell you what they really think,” he says. “I am also familiar with the workings of the local government.” Mei worked for 13 years in the Chinese chemical industry before moving to the U.S. to study for a doctorate in chemistry. A particular advantage for Mei has been his knowledge of lianxi and the contacts he has that are now in senior positions in business and government. Mei says the industry experience helped him obtain the Shanghai Hercules job — and it is not easy for workers to make the step from the lab to operations management. “To work for this kind of joint venture is pretty tough,” Mei says. “China-born staff working in R&D need to show that they are willing to learn some business management skills to get a position.” Demand for China-born staff with a mix of technical and business qualifications is increasing. Shanghai-born Ph.D. Chemist Allan J. Hong,

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was until recently manger/chemicals portfolio for Roche Pharmaceutical, which included extensive dealings with Roche’s Chinese joint venture. He was recruited by Praxair and will join the Praxair China management team at the end of January. “There are a great many China-born Ph.D. chemists working in the US chemical industry, but almost all are bench scientists and they don’t have exposure to managerial training,” Hong says. He was a senior scientist at Roche until 1992 and was able to use his work experience in consulting and a business leadership course to obtain a managerial position. “China-born scientists with international business experience are in a unique position to help multinationals develop their positions in China,” agrees Kewen Jin, a Chinese biomedical scientist who is associate director/ international market planning with the Wyeth-Ayerst division of American Home Products. “They can bring not only cultural knowledge and language skills, but also the networking abilities.” While the image of guanxi may have been tarnished by past association with corruption, Jin says it is still an important tool, particularly when companies are looking at potential joint ventures in China and while the country’s legal framework is still weak. “It may be that you don’t actually know the person, but through networking you can run almost a trustworthiness check,” he says. Hong says that a combination of Chinese business insight and Western management tools are the keys to business success in China. “Understanding guanxi and its practice has become critically important to integrating a foreign business in China,” he says. “It will remain an important part of corporate culture in that things get done by who you know, not by what you know.” Western management already uses business networking as a tool and reaching customers by networking can be a cost-effective approach over major market schemes, Hong says. Multifunctional teams in large companies also accomplish projects via networking, he adds. Those techniques, as well as approaches such as management by influencing, “share characteristics similar to guanxi,” he says. Many foreign businesses in China employ expatriates from Hong Kong, Taiwan, or Singapore, particularly as many have experience with Westernstyle management. These people can speak Chinese and may have an understanding of Chinese business customs, acting as a bridge for business

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communication, Hong says. However, they are still generally considered foreigners in China. “What foreign businesses in China need are some Chinese staff who have studied and worked in foreign countries, preferably with some management experience,” Hong says. “The few Chinese people who got their MBAs outside China became hot property in the foreign banking and consulting industries. Very few Chinese employees are in management for manufacturing-based companies,” he says. Meanwhile, the scant availability of experienced local staff continues to frustrate foreign firms with Chinese joint ventures. Chinese technical graduates with the qualifications for working in a chemical joint venture are rarely fluent in another language, while language school graduates lack the technical training. Those with both skills are in demand and are apt to move up to a higher bidder. “To hire high-quality local people with technical qualifications, work experience, and foreign language skills is very difficult,” says Mei of Hercules. Most in demand, Mei says, are locals with five to ten years of experience in the chemical industry and with sufficient language skills. Source: Adapted from Chemical Week (1995).

Minicase 3: Joint Venture Mode and Guanxi Although joint ventures are no longer legally required on legal grounds in China, they are making a resurgence. At first glance, this would seem strange. Under the regulations of the 1980s which made other forms of doing business all but impossible, many foreign companies found themselves in unwanted and frustrating relationships. Unsurprisingly, when the regulations were eased in 1990, firms were enthusiastic to establish wholly owned companies, and by 1992 this later category represented almost a third of the investment into China. Frustration with joint ventures was reflected in a survey of some 60 ventures Booz-Allen and Hamilton, an American management consultancy, carried out in late 1993. It found that almost 90 percent of the companies interviewed were frustrated by their partnership arrangements. The frustration

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was not linked to nationality — it was present in European, Japanese, and North American ventures. Booz-Allen termed the problem of these ventures, the “empty vessel” syndrome: the venture company in China is empty of competitive strengths. Over the last year, however, a set of reasons for re-considering joint ventures has emerged. Following three themes have predominated in the renewed interest in joint ventures: (1) The high-speed industrial revolution: The markets and structures of many of China’s industries are going through an industrial revolution. In particular, both the industrial and consumer markets are frequently characterized by bi-modal demand. For example, for one engineering product, some 25 percent of the sales were at close to world prices, the remaining 75 percent were at local prices, around one tenth of the world price. The premium-price segment has been largely created and dominated by foreign firms and the low-price segment by local firms. The inviting “hole in the middle” is unlikely to stay empty for very long, especially for companies that can establish an indigenous cost base. Although an indigenous cost base could be reached through a wholly foreign-owned entity, this route often faces the challenge of overcoming significant diseconomies through poor utilization at the startup stage, particularly if the products needed to have specific adaptations for the Chinese market. As a result, an existing company, as a foundation, can be attractive. (2) Opportunities from reform: China’s current reform program is seeking foreign participation in some industries to speed up their modernization. Since 1992, and the adoption of the concept of a “socialist market economy,” a consensus has emerged on what needs to be achieved to create competitive industries. In particular, this involves: (i) establishing a regulatory framework within which business can operate, including property law, corporate law, tax codes, and so on; (ii) furthering the emergence of competitive industries including the main manufacturing companies, as well as their supply and distribution structures; and (iii) creating professionally run enterprises. Although there is a remarkable consensus that these three initiatives need to be pursued, there is little or no agreement on the means. In particular, the views among the officials involved range from laissez-faire to interventionist.

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Foreign companies are expected to play a vital role in providing know-how and cash through joint ventures. (3) Continuing “fix it” value: Although the scale of the opportunities in China presents a major strategic challenge, much of the managerial challenge remains principally operational. Many problems are insoluble without the right sort of contacts with the right sort of people. A key value for an alliance or joint venture is therefore: (i) to facilitate entry and access to land, assets, people, permits, and so on; (ii) to mediate with local business practices; and (iii) to provide insurance against uncertainties, typically political ones. The goal of an alliance in this case is not, however, access to business skills or resources — the prime rationale elsewhere in the world — but is to give incentives to influential people to assist the business. These pressures are leading to reconsideration of the joint venture and its two leading types of alliances. The first is the guanxi or “connections” alliance, where the goal is to have friends when needed but to limit their participation, or meddling, in the business. The second is the “leapfrog” alliance, where the hope is to create a leading company in 10 years time. Although this type of alliance does not require a joint venture, in many cases this is how it is executed. Such an alliance was summarized by the regional head of one overseas firm as “a 15 percent alliance,” where, although the foreign side cannot know whether it will really be of value, it is prepared to part with 15 percent of the equity as a comfort factor. The connection alliance is epitomized by some of the tie-ups in Hong Kong, notably those involving China International Trust and Investment Company (CITIC), the investment arm of the State Council. In other cases, the partner has been an overseas Chinese company, typically a Hong Kong one with good connections. Some of the Hong Kong connections are already at their limit, however. As the head of one major Hong Kong company put it: “My connections are too precious to use them up on others’ problems.” The challenge with the leapfrog approach is whether it is possible to turn a sow’s ear into a silk purse. The Chinese government is willing, indeed eager, to discuss foreign participation in non-strategic industries. In one case in consumer goods, for example, the government had been holding discussions on allowing several of the leading domestic companies to merge

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with outsiders. This could speed the emergence of well-run companies and lighten the financial burden. In one example of a leapfrog alliance, a Western consumer goods company acquired a controlling interest in a state-owned enterprise. The company was already an industry leader, but by external standards was inefficient and unsophisticated. The initial effort from the foreign side has concentrated on establishing some of its products through the state-owned firm. This has involved high levels of advertising and in-store promotion, extensive work with the sales force to get the product into the state firm’s existing wholesale network, and investment in new factory equipment. The scale of the effort has proved daunting and the company has not yet tackled any of the social issues, reasoning that these are less pressing than the challenge of modernizing business processes. There are many unknowns with these emerging types of alliances. Can the guanxi alliance really deliver and is it worth the cost and inflexibility? Can the social and other problems with leapfrog alliances really be solved? Whether there will be other, better, ways will depend on an individual company’s position. For example, one leapfrog venture, when reviewed with a hard eye, brought only connections compared with going-it-alone. It was not worth the investment. Similarly connections can sometimes be made for less cost. A number of overseas Chinese companies have given the people with whom they wanted to maintain ties a consulting role, or something else less formal than 15 percent of the equity. Further, it is unclear how long the needs driving the choice of a venture will last: entering a venture that will probably last 15 years or more is not the best solution to a problem that may be gone within two years. This points to the need for companies to see joint ventures as one step on the staircase, not as an end in themselves. Firms should always think beyond the venture and to the options that may be available to them later. As one executive commented, “By the turn of the century we will easily be able to participate with a 100 percent-owned company. The reason for entering a venture today is timing: to make an impression in an expanding market and to match our competitors. But we don’t want to enter a venture that will foreclose our option of having our own presence in a few years.” Source: Adapted from Jones (1994).

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Appendix 1 Summary of Anti-Corruption and Anti-Bribery Laws and Rules in China

Forms of Corruption Identified in the Legal Codes Given the different moral standards, values, and economic organization of the capitalist and the socialist systems, the actions that are proscribed and the forms corruption takes in the two systems are not identical. In China, there are as many forms of corruption as there are rules forbidding such actions. This appendix focuses only on the examples cited as corruption in the central government legal documents. These are seizure (qintun ), theft (daoqie ), fraud (pianqu , misappropriation (taoqu ), extortion (suohui ), bribery (shouhui ), embezzlement (tanwu ), smuggling (zousi ), and speculation (touji daoba ). While the Chinese meanings are similar to their English translations, they also have their unique connotations. Because simply superimposing our Western understanding can distort their meaning, we examine each term in the Chinese context, except for nuo yong and embezzlement, which were discussed in an earlier section. Qintun is the seizing of other people’s property. According to the 1979 criminal code, it can be committed by individuals in either their private or public capacities. As in the rest of the proscribed acts to be discussed, however, we are referring specifically to those acts committed by state employees. Qintun occurs most often when one person or party is more powerful than another, and the former imposes its will on the weaker. It is common in developing countries where the rule of law is weak. Throughout Chinese history, local officials held inordinate power, and corrupt ones took what they wanted from the powerless populace. Victims were too afraid to resist,

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but when they did, the officials resorted to force — qintun accompanied by physical violence became daoqie (robbery/larceny). Pianqu, or zhapian (fraud), is the intentional perversion of truth for the purpose of inducing another to part with his/her personal belongings. Taoqu, a term that appeared in the 1952 statute, has a similar meaning, but it is no longer popular. Chinese officials had great powers and would simply demand what they wanted from their subordinates or charges who were ignorant of their rights, but these same officials would have to file misleading or false reports misrepresenting themselves or their organizational achievements to obtain materials or recompense they were not entitled to from their superiors. Shouhui (bribery) is receiving anything of value in the discharge of one’s duties beyond what is stipulated in the official guidelines. Shouhui is when state employees accept but do not actively solicit such payments; suohui (extortion) is when they actively demand these illicit rewards by threatening to or actually do withhold services or materials to which their clients are entitled, if their requests are not granted. Like qintun, suohui or extortion occurs less frequently in the urban areas, than in the rural areas where the influence of the central government is weak, the powers of the local officials is strong, and state employees are often the sole dispenser of goods or services. Touji daoba (speculation) is buying and selling goods in ways that produce unreasonable profits. What constitutes reasonable profit is subject to debate and fluctuates over time; for a long time, the Chinese government definition of speculation certainly did not coincide with that in the West. It is difficult to identify the acceptable rate of such returns in China, but perhaps the five percent interest paid to owners of confiscated property in the early fifties provide some indication of the official perception at that time. Soon after, the Communist government outlawed private trade, branding anyone engaged in such activities guilty of speculation. Distrust in commerce has its roots in tradition as well as in the communist ideology. Traditional Chinese culture placed a high status on farming; merchants were the lowest rung of the occupational scale after scholars, farmers, and workers. Furthermore, Marxism has always placed a premium on production rather than on the circulation of goods. Before 1976, the Chinese Communists regarded trade

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as the hallmark of capitalism; however, their attitude changed in the open economic climate of the late 1970s. Trading outside state jurisdiction was no longer considered speculation. Profit-making was not only tolerated but even encouraged. Nonetheless, those who made profits through simply trading goods without adding value to them by processing could still expose themselves to accusations of price gouging. Smugglers (zousi fan ) in the West generally are those who move contraband or goods across national borders without paying the required duties. Again, the Chinese definition of smuggling deviated from that of the West. Between 1949 and 1976, when the market was regulated by the government, zousi (smuggling) was simply taking products from one city, region, or province to another without official authorization. In the eighties, the government deregulated state control of a large number of products and smuggling in China began to look more like that in the West. Television sets, stereos, and even cars were transported across the national borders and distributed throughout the country without state authorization and payment of the required taxes. In the West, state officials involved in smuggling and speculation would most likely be charged for not paying import taxes or dismissed for their participation in “outside” activities; Chinese state officials, in contrast, would be punished for participating in otherwise state-controlled activities — trade and the movement of goods that are organized by the government. Because state officials (more than private citizens) are privy to information on the distribution of goods and they have easy access to the materials, capital, and transportation facilities needed for smuggling and speculation, they are more likely to defy state regulations to enrich themselves. Moreover, these two crimes often go together because the easiest and most common way to make a profit (speculation) is to transport goods from an area where the prices are low and sell them at another where they are high (i.e., smuggling). The 1988 Provisional Regulations on the Penalties for Corruption and Bribery of State Administrative Personnel focused on state employees accepting gifts, commissions (kickbacks), and administrative fees or soliciting other forms of income not specified by the state — illicit activities common among state employees of the period.

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If some behavior banned by law as corruption is controversial, then the activities proscribed in the administrative codes are even more controversial. The rules of behavior in the administrative documents are more restrictive than those of the legal code passed by the National People’s Congress. The administrative codes warned against dereliction of duty, false accusations, shifting blame, living lavishly, and other such activities. In the 1980s, state employees were reminded to eschew corruption and inappropriate behavior (bu zheng zhi feng ) which included bureaucratism (acting like a bureaucrat), squandering public money, enjoying special privileges, accepting bribes, using the backdoor, and cliquism. Much of the behavior banned in the administrative codes falls into the area of grey corruption in another way. Not only would the courts fail to prosecute state employees for womanizing, banqueting, minor misappropriation of public property or nepotism; the public generally would tolerate limited forms of these behavior. The public condemned nepotism, but personal relationships were deemed important in the particularistic Chinese culture, and people were expected to do favors for family and friends. State employees who turned down such requests might be praised by some as upright officials, but might be considered inflexible and unreasonable by others. Moreover, in the hierarchical nature of traditional Chinese society, those at the top were entitled to more privileges than those below. Sybaritic practices among officials were often overlooked as perks that came with these positions so long as these were not excessive. This ambiguity, inconsistency, and lack of consensus in public opinion as well as the incongruity between official and public perceptions undermine the effectiveness of administrative regulations fostering honest governance.

New Rules and Regulations The anti-corruption campaign since the late 1980s was intended to curb the divergent ideas and conduct of cadres and to rally the Chinese people around the party’s cause. The campaign was, therefore, designed from above and implemented along hierarchical lines. In contrast to previous efforts, however, the campaign in the context of reform tried rational-legal methods.

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Having realized the problems were associated with the legitimacy based on charismatic or traditional claims, the party now saw the necessity to rely on legal means to contain corruption. Thus, the party’s flagging legitimacy could be restored on a new and rational basis. From January 1988 to March 1989, in about one and a quarter years, the party and the government issued about 30 documents to specify anticorruption rules. These rules and regulations could be classified into three major categories: 1. Strengthening the centralized control over certain commodities and production materials. For example, according to a document issued in October 1988, a government unit must report its purchase of important commodities to its superior; the commodities subject to prepurchase approval increased from 19 to 29 kinds, including automobiles, sofas, carpets, office furniture, blankets, washing machines, refrigerators, TV sets, vacuum-cleaners, clocks worth over 50 yuan, lamps worth over 100 yuan, and imported liquors and cigarettes. In late 1988 and early 1989, steel and chemical fertilizers were put under the monopoly of the central government. 2. Forbidding certain “unhealthy practices,” such as gift-giving in public affairs, squandering public funds, cadres’ engagement in trade, and excessive consumption of liquors and cigarettes in receptions. 3. Establishing rules and procedures to punish offenders. The Interim Provisions Governing Disciplinary Sanctions Against Corrupt Functionaries of State and Administrative Organs, for example, stipulated the following disciplinary penalties for embezzlement: (a) anyone who embezzled more than 5000 yuan should be removed from office but the money he or she embezzled should be repaid in full plus interest; (b) anyone who embezzled 3000–5000 yuan or who embezzled money in order to make a profit, should have this serious offense put on record and receive a penalty up to removal from office, with the money being repaid; and (c) if everything is the same but the money he or she embezzled was less than 3000 yuan, a person should have the offense put on record or receive a demotion penalty (RMRB, 22 September, 1989).

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Since the party perceived a close connection between the problem of official speculation and the proliferation of government corporations, it believed that a campaign to “clean up” corporations was necessary. The “clean-up” was implemented between October 1988 and December 1989. During the period, the party center and the State Council issued two important documents. One was the Resolution to Clean Up Corporations issued in October 1988. It aimed at corporations run by government agencies, which, according to the central authority, should not engage in profit making. The document asked all government agencies to disconnect themselves from business corporations and it emphasized that no government agencies were allowed to take money out of their administrative budget or other government grants to invest in business. Later, in August 1989, another document was issued — the Resolution to Further Clean Up Corporations. The second document expanded the targets of the clean-up to include illegal or ill-managed non-government corporations, especially those involved in trading raw materials and key production goods. The document reaffirmed that the production and trade of raw materials and certain industrial goods remained under the jurisdiction of the central government. The party leadership saw the following particular problems with the government corporations, in addition to the damage caused by their profiteering activities to the center’s control over the means of production: they jeopardized the fairness of market competition, because they had monopoly power over important materials and products; their buying–selling–reselling activities caused drastic price increases; they also made raw materials stay in circulation, being sold and resold, without going into production; and finally, perhaps more importantly, they affected social morality and brought a bad image to the party and the government. As a result of the intensified clean-up efforts, by the end of April 1990, 88.8 percent of some 13 390 companies run by party or government agencies were abolished. The rest were transferred to economic sectors. About 2700 of them had been established by central ministries and other government bodies at the center. In addition to clamping down on illegally run or ill-managed corporations, the party center also banned its cadres from holding concurrent positions in corporations. On 5 February 1989, the Party Central Committee and the State Council circulated a notice requiring all the cadres who concurrently

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held positions in state apparatus and business corporations to quit their jobs in business. According to official statistics, one year after the decision was made, 96.4 percent of these cadres pulled themselves out of business. The party center also publicized four “big cases” to show how some cadres had worked as go-betweens by means of their concurrent positions in government and in corporations to make profit. Ge Datong of Economic Daily, Chen Kaizhi of North China Industrial Corporation, Zhang Shuchun of Yanshan Chemical Corporation, and Xiang Yan of Jiangshu Zhenhua Chemical Industrial Corporation, were party cadres working for newly established government corporations. Taking advantage of their privileged access to important materials and products, they created great personal fortunes, ranging from several million to several hundred million yuan. They all received heavy sentences. The leadership paid particular attention to official speculation conducted by corporations. From October 1988 to June 1989, 25 884 cases of official speculation were investigated and handled, concerning 25 404 companies. Among them, 9534 received economic sanctions, with 260 million yuan being recovered; 2871 received the penalty of license suspension; 301 cadres were pursued on criminal charges for their illicit economic activities. To highlight the top leadership’s determination, the party center also publicized the cases of high-profile corporations such as China International Trust and Investment Corporation, Kang Hua Development Corporation, China Economic Development Corporation, and China Agricultural Trust and Trade Corporation. The investigation results of these corporations and their hundreds of subsidiaries showed that these “super” corporations had been engaged in illicit activities such as tax evasion, speculation in productive materials, and black market transaction in foreign currencies. The Central Audit Bureau recovered a total of 5133 million yuan (approximately US$900 million) from these corporations. Since 1998, the Standing Committee of the Political Bureau of the Central Committee of the Communist Party of China urged the army, the armed police, and the judiciary to thoroughly sever their links with their enterprises as part of a national campaign against corruption. Smooth progress has been made by the army and armed police divisions as well as judiciary departments in halting their business activities and cutting their ties with

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enterprises. However, there are concrete and complicated procedures that must be followed to transfer the enterprises to the localities completely. Special attention has been paid to possible incidents of bribery, dereliction of duty, embezzlement of State assets, and other offences which may occur in the process of transferring the enterprises to the localities. The army, the armed police, and judiciary departments have been urged to give full appreciation to cutting off links with their enterprises, a move which has won strong support from the masses. China’s legislators are also discussing a proposed supervision law that may ensure the new constitutional principle of the “rule of law” and curb corruption among government officials. Legislation on government oversight has once again gained prominence, this time in the form of various motions raised by deputies to the annual session of the National People’s Congress (NPC). Nearly 300 deputies out of 2978 called for the early enactment of such a law. Although China’s Constitution authorizes the people’s congresses to oversee the performance of the government and elected officials, no specific procedures are identified. The future supervision law should require government officials to meet legal standards and include corruption prevention and detection mechanisms, many deputies believe. Since the early 1990s, many provincial and local people’s congresses have been experimenting with methods of implementing their constitutional rights. Shaanxi province was the first to start so-called “democratic evaluations” of key government leaders, chief judges, and prosecutors in 1993. In the past several years, people’s congresses at provincial, city, and county levels have summoned over 1000 officials, including one vice-governor, to report to legislators and answer queries face-to-face. The legislators would then write a formal evaluation report, listing the merits and shortcomings of officials being evaluated. The officials, in turn, would work out proposed solutions and report back to the people’s congresses. China’s top legislature also plan to formulate its first public bidding law to outlaw unfair trade and corruption in this sector. China urgently needs to formulate a law governing public bidding in order to improve investment efficiency and safeguard the quality of construction projects for the state. Since early 1980s, China has carried out a public bidding system in the use of foreign funds, the importing of large-scale machinery equipment,

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the distribution of huge construction projects, and the allocation of export quotas among domestic manufacturers. However, the country has yet to adopt a law standardizing practices in this regard. In general, the public bidding system can boost the reform of investment and finance, create a fair market environment, and improve the quality of construction projects. The draft law stipulates that contractors must secure the right to build infrastructure projects, public facilities, and projects financed by international or foreign funds through public bidding. Two of the methods chosen for future practice will be open bidding and invitation bidding, both of which are accepted worldwide. Appraisal committees, which should comprise of veteran technological and economic experts, will make final decisions on public bidding, according to the draft law stipulations. To strictly safeguard project quality, the draft law prohibits illegal sub-contractors. Before the economic reforms of the late 1970s, government bodies allocated construction projects and official purchases in accordance with previous plans rather than market needs. In 1984, only 4.8 percent of all construction projects in the country were allocated on the basis of public bidding. But this percentage has now risen to 60 percent. Contracts for machinery-equipment trade which arrived through open bidding were valued at more than one billion US dollars this year in China, and government bodies now also purchase office articles, vehicles, and services through public bidding. At the same time, China is pouring more funds into infrastructure to stimulate sustained economic development. The latest statistics show that illegal activities in public bidding for construction projects now account for over 40 percent of all economic criminal cases. For example, this sort of activity is thought to be responsible for recent bridge collapses and sinking roads in Chongqing municipality, and Yunnan and Liaoning provinces. None of these poor-quality projects were subject to public bidding or strict supervision.

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Appendix 2 Summary of Anti-Corruption and Anti-Bribery Laws and Rules in the United States

The Anti-Bribery Provisions The corrupt party: The definition of “domestic concern” and public company (“issuer”) The foreign bribery provisions of the Act apply to all United States companies and officers, directors, employees, agents, or stockholders acting on behalf of such companies. The law comprises two similar sections — one which covers publicly held companies, or “issuers,” and the other which applies to all other “domestic concerns.” An “issuer” is simply any company registered under Section 12 of the Securities Exchange Act of 1934 and any company required to file reports pursuant to Section 15(d) of that Act. A “domestic concern” is broadly defined as (1) a business entity which either has its principal place a business in the United States or which is organized under the laws of the United States or any state, territory, or possession; or (2) an individual who is a United States citizen, national, or resident. Thus, activities by wholly-owned United States subsidiaries of foreign corporations, or those entities controlled by foreign companies, are within the ambit of the FCPA. Significantly, actions outside the United States by United States citizens, nationals or residents even if performed for foreign corporations, are swept up into the Act’s prohibitions and, at a minimum, could create liability for those persons with attendant negative publicity for the entities that employ them. As a practical matter, it is difficult to envision 323

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a situation involving a totally foreign corporation, whose securities are not traded in and which is not based in the United States, having a United States citizen, national or resident charged under the FCPA for an activity undertaken in a third nation on behalf of his foreign employer. However, that having been said, it would be equally unwise for a foreign corporation to assume that, for political reasons, the United States government would not employ the FCPA, antitrust laws or any other statute, to attempt to “level the playing field” for United States economic or political interests. (a) Foreign Subsidiaries Although foreign subsidiaries of United States business are not specifically mentioned in the law, the actions of foreign subsidiaries are incorporated into the reach of the law through the language which prohibits indirect foreign payments or offers. The question of whether the percentage of ownership interest by the parent in the subsidiary (that is, whether it is more or less than 50 percent) affects its liability is still open. Additionally, the question of whether a joint venture with a foreign company exposes the domestic company to liability also remains unresolved. Both situations will turn on the facts of a particular transaction. (b) The Requisite Intent: “Corruptly” to Influence An Official Action The FCPA prohibits United States concerns and issuers from “corruptly” using the mail or any other means or instrumentalities of interstate (including foreign) commerce for making a payment or providing anything else of value for various business purposes to foreign government officials. The term “corruptly” is not defined in the FCPA. As a result, several possibilities have been postulated for how the term should be defined in the context of the FCPA; however, the legislative history indicates that the term “corruptly” is to be construed in a fashion which is analogous to the use of that term under the domestic bribery statute, 18 USC Section 201(b). The courts have adopted this viewpoint and given support to the position that “corruptly” should be interpreted the same way under the FCPA as it is under the domestic bribery statute. For example, in United States v. Liebo, the court held that a jury could properly infer corrupt intent from the defendant’s act of giving a gift to a close relation of the foreign official

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where the surrounding circumstances sustained the reasonable inference that the “gift” was made for the purpose of influencing the foreign official’s decision-making process. It is interesting to note that the payment, or “gift”, in Liebo was not made to, nor did it benefit, the particular government official that Liebo “intended” to influence. Liebo had bought airline tickets which benefited the cousin of the foreign official. It is also interesting to note that in Liebo, subjective intent of the defendant was inferred from the surrounding circumstances. Since the prosecution of a FCPA violation is necessarily post facto, it is important to be mindful that activities will be judged with the benefit of hindsight. If the transaction results in an economic benefit conferred on a decision-making official (or on a close friend or family member), the inference of corrupt purpose is substantial.

The recipient of the corrupt payment: Any “foreign official” Unlike the term “corrupt”, the FCPA does define the term “foreign official.” A foreign official is “any officer or employee of a foreign government or any department, agency, or instrumentality thereof, or any person acting in an official capacity for or on behalf of any such government or department, agency or instrumentality.” The FCPA requires that the “foreign official” be engaged in an official capacity or lawful duty when the alleged illegal conduct occurs. In effect, this makes the definition of foreign official analogous to the term “public official” as defined in the domestic bribery statute. Under the domestic statute, all that is required to qualify as a public official is that the “individual must possess some degree of official responsibility for carrying out a federal programme or policy.” In other words, it is not necessary that the individual be an employee of the government. While this presents what could be termed a difficult situation under the domestic bribery statute, it may be treacherous under the FCPA. Often, officials in foreign countries act in a public and private capacity simultaneously. For example, payments to officials of state-owned companies have constituted a violation of the FCPA. Care must be exercised in this area because “foreign officials” may apply to anyone who exercises “official” influence over an “official” enterprise.

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The medium of payment: “Anything of value” The FCPA prohibits the corrupt payment, offer, gift or authorization of the giving of “anything of value”. Although the medium of corrupt payment is often cash or cash equivalent, the term “anything of value” reaches payments of non-cash items. For example, charitable donations, travel expenses, loans with favorable interest and repayment terms, trips and the services of a prostitute have all been held to constitute corrupt payments under the FCPA and the bribery statute. In short, the gift or promise need not be shown to have a specific economic value. Indeed, it need not be something that anyone else in the world would find “valuable.” The test is whether it was something that the intended recipient wanted, asked for, or placed a value on, whether real, psychological, physical, or emotional. If so, the test for “anything of value” has been met. As is obvious, the phrase “anything of value” is interpreted very broadly. In fact, the medium of corrupt payment may not even have any monetary value whatsoever or even in fact exist. In Williams, a domestic bribery case resulting from the ABSCAM investigation into payments to members of the United States Congress, the “thing of value” was stock in a fictitious titanium mining venture. Objectively, stock in a non-existent company has no negotiable value; however, under the anti-bribery provisions, its perceived value is sufficient to uphold a conviction.

Payments to third parties: “Knowing” the payment will be made to a foreign official As noted above, the FCPA also prohibits payments to third parties with the knowledge that “all or a portion” of the payment will be made, “directly or indirectly” to a foreign official. The substitution of the term “knowing” for “reason to know” was one of the concessions made in the 1988 Amendment to the FCPA. The FCPA defines a person’s state of mind as “knowing” if either: (a) the person is “aware” that he or she is engaging in the conduct; or (b) if the person has a “firm belief ” that a result “is substantially certain to occur.”

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The FCPA further provides that where “knowledge” of a circumstance is required, such knowledge can be established “if a person is aware of a high probability of the existence of such circumstances ….” Exception is made “if the person actually believes that such circumstances do not exist.” Although “simple negligence” and “mere foolishness” are not a basis for culpability under the FCPA, the concept of “conscious disregard” and “wilful blindness” are incorporated into the definition of “knowing” conduct. Thus, liability cannot be avoided by turning a blind eye to the practices of subordinates within a company, or to the realities of the situation in the foreign country. However, it should be noted that at this point, the exact scope of the term “knowingly” has not been developed in the context of the FCPA. Corporations which have been facilely advised by their lawyers or others not to make too broad an inquiry in order to escape liability under the anti- bribery provisions of the FCPA may well be maneuvering themselves into a violation of the accounting and internal controls provisions applicable to public corporations. Not only would these corporations be in derogation of their responsibility to know the use and disposition of corporate assets and that such be in accordance with general or specific management directives, but those involved could face civil or criminal suits on another ground. Assets of a corporation not used to advance the business or interests of the corporation may come within the concepts of wasting of corporate assets, breach of fiduciary duty, or self-enrichment.

“For the purpose of influencing” an official act or decision The intent of the giver controls the determination of the purpose of the payment or gift. Like many of the other phrases in the FCPA, determination of this element involves a backward look at the facts. The examination will entail looking at the recipient, the relationship of the recipient to the activity desired by the giver and whether the recipient or someone the recipient was intended to influence had the ability to act or omit to act in a matter that affected the giver’s obtaining or retaining of business. Payments for the performance of ministerial functions or to induce a government official to

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perform an act which they are already legally or contractually required to perform are not violative conduct.

“Obtaining or retaining business” The idea of “obtaining” business should not require extended discussion except to note that gifts or payments to foreign officials to draft requests for contract proposals in such a manner as to disfavor competitors or make them unable to bid is within the statute. “Retaining” business likewise affects elimination of competition and relates to multi-stage projects where each stage is separate and bids are made and approved separately.

Defences and Exempt Transactions Exempt transactions Under the revised provisions of the FCPA, there is an explicit exemption for certain “facilitating payments” where the purpose of the payment is to “expedite or to secure the performance of a routine government action.” For the purpose of the Act, a “routine government action” refers only to actions that are ordinarily and commonly performed by a foreign official in connection with: 1. obtaining permits, licences, or other official documents to qualify a person to do business in a foreign country; 2. processing governmental papers, such as visas and work orders; 3. providing police protection, mail pickup and delivery, or scheduling inspections associated with contract performance of inspections related to transit of goods across country; 4. providing phone service, power and water supply, loading and unloading cargo, or protecting perishable products or commodities from deterioration; or 5. actions of a similar nature. The Act makes clear that the term “routine government action” does not include “any decision by a foreign official whether, or on what terms, to award new business to or to continue business with a particular party,

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or any action taken by a foreign official involved in the decision-making process to encourage a decision to award new business to or continue business with a particular party.” The exemption for facilitating payments, thus, is quite limited in scope. Also note that even though a payment is exempt from the bribery provision of the FCPA, it is not exempt from the accounting provisions. It must be disclosed accurately in the financial statements and in the company’s books of original entry.

Statutory affirmative defences The 1988 Amendment recognizes two affirmative defences to liability under the Act: first, that the payment was lawful under the written laws of the foreign official’s country; and second, that the payment was reasonable and bona fide and that it related to promotion of products and execution of the contract.

Lawful payments The FCPA provides that it shall be an affirmative defence that: The payment, gift, offer or promise of anything of value that was made, was lawful under the written laws and regulations of the foreign officials, political party’s, party official’s, or candidate’s country ….

It should be noted that the payment must be legal under the foreign country’s written laws; therefore, “custom” is not a defence to prosecution under the FCPA.

Reasonable and bona fide promotional expenses The FCPA also contains an affirmative defence in the situation where the payment was made in association with (a) a promotional effort; and (b) the execution or performance of a contract:

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The payment, gift, offer or promise of anything of value that was made, was a reasonable and bona fide expenditure, such as travel and lodging expenses, incurred by or on behalf of a foreign official, party, party official, or candidate, and was directly related to: a.  the promotion, demonstration, or explanation of products or services; or b.  the execution or performance of a contract with a foreign government or agency thereof. It should be cautioned that this defence only applies when the payment was made in good faith; therefore, if the payment is, in reality, a bribe or is otherwise a corrupt payment intended to influence an official act, the defence would not apply. It should also be cautioned that the above defences do not alter the basic requirement to accurately reflect these transactions in the company’s records.

The Foreign Corrupt Practices Act (FCPA) The United States has been a world leader in combating corruption in the global marketplace for some time. The Commission has been — and will continue to be at the forefront of that effort. Among the statutory tools that the SEC relies upon is the FCPA. Enacted 20 years ago, the FCPA makes illegal the payment of bribes to foreign officials for the purpose of obtaining or retaining business. The FCPA also created books and records and internal controls provisions of the federal securities laws that have been more generally used by the Commission to combat fraud. The problem of bribery by United States corporations doing business abroad first surfaced during the 1970s when the press reported allegations of questionable payments by United States companies to foreign government officials. In 1973, several corporations and executives were charged with using corporate funds for illegal domestic political contributions by the Office of the Special Prosecutor of the Department of Justice. Since the nondisclosure of these activities might entail violations of the federal securities

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laws, the Commission published a statement of the view of the Division of Corporation Finance concerning disclosure of these matters in public filings. This release explains that indictments, guilty pleas, and convictions of corporations or their officers or directors for illegal acts are “material to an evaluation of the integrity of the management of the corporation as it relates to the operation of the corporation and use of corporate funds.” Commission staff also discovered falsification of corporate financial records to conceal the use of corporate funds as well as the existence of secret “slush funds” disbursed outside the normal financial system. The resulting investigations culminated in settled injunctive actions against 14 companies as of 10 May 1976. As a result of the potential magnitude of the problem, the Commission began a voluntary disclosure program under which the Commission offered not to bring enforcement actions against companies that disclosed past payments and agreed to implement internal procedures to prevent bribery in the future. Under the program, over 400 United States companies, including 117 of the top Fortune 500 companies, admitted making questionable or illegal payments in excess of US$300 million to foreign government officials. The Commission submitted a report to Congress together with a legislative proposal.

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Appendix 3 Transnational Cooperation in Combating Corruption and Bribery

International Dimension Acceptance of the FCPA both in the United States and abroad has been slow and grudging. Anti-corruption statutes are often seen by business managers as unrealistic in light of the normative behavior pattern in a foreign country and likely to result in an unfairness which does not apply to foreign competitors. It is seen by many as weakening the ability of American companies to gain a foothold in some of the fastest-growing international markets. A few companies called for repealing the FCPA. Other companies simply complain about it. While one obvious solution would be to repeal the law, the better and more challenging solution is to encourage other nations to raise their standards so that they enact similar statutes to the FCPA. From the inception of the FCPA, this has been the goal. However, nearly 20 years after Congress passed the FCPA, the United States remains one of the few if not the only nation in the world which prohibits its businesses from bribing foreign officials. In fact, European and Japanese competitors can even deduct bribes from their taxes. As one commentator put it: “If a German bribes a German, he gets thrown in jail; if he bribes a foreign official he gets a tax deduction.” This is the situation in most European countries. In countries such as Germany, Greece, Luxembourg, Belgium, and France, foreign bribe payments are tax deductible in whole or part. Even worse is the attitude of government officials of developing countries: the Kleptocrats. They often expect to become more wealthy through international trade. In March, it approved a series of guidelines which urge their involvement in politics. As a result, United States businesses often 333

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find themselves at a competitive disadvantage when bidding against foreign companies for contracts in Kleptocracies. As one writer said, “Competitors grease palms that United States developers are legally bound to merely shake.” However, the days in which United States businesses are forced to play by a different set of rules may be coming to an end. Surprisingly, perhaps, this is not because the United States has abandoned the FCPA, but rather it is the result of the rest of the world beginning to see the necessity for curtailing the practice of corruption in the international marketplace. In fact, remarkable progress is being made. On April 11 1996, the Organisation for Economic Cooperation and Development (OECD), which comprises the world’s 26 leading industrial nations, passed a resolution stating that bribes made to foreign officials should no longer be tax deductible. Member nations are now expected — but not legally bound — to rewrite their tax laws accordingly; the OECD has set up a watchdog group to monitor the changes and report on the progress within one year. The OECD is also seeking to pass another resolution making bribery of a government official a criminal offence. On 22 May 1996, overcoming last-minute objections from France and Germany’s resistance to the effort, the OECD members agreed to “criminalise the bribery of foreign officials in an effective and coordinated manner” and to reexamine the tax deductibility of bribes where this was still permitted. Ministers agreed to consider proposals on anti-bribery next year. The 52-member Commonwealth has come forth in support of the OECD efforts to contain international business corruption. The OECD has also recommended that their governments take action to introduce anti-corruption provisions into contracts funded by their aid budgets. Also in March 1996, the International Chamber of Commerce (ICC) issued guidelines to its 7000 business members urging them to adopt enforceable codes against bribery and to insure transparency in accounting for political contributions. The ICC also called on governments to write tougher legislation and to repeal laws allowing tax deductibility for foreign bribes. The ICC intends to press the World Trade Organization (WTO) at its December 1996 meeting for a study on the impact of bribery in distorting and hindering its members to adopt enforceable codes designed to counter bribery and ensure transparent accounting of any political contributions. It also

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calls on governments to toughen legislation on bribery and extortion, and to remove opportunities for companies to write off bribes against tax bills. On 29 March 1996, 21 member states of the 34 member states of the Organization of the American States (OAS) signed the Inter-American Convention Against Corruption at an annual meeting. The treaty requires each signatory country to make bribery of foreign officials a crime and an extraditable offence. This is the first extension outside the United States of the approach taken in the FCPA. In a gesture more symbolic than substantive, on 2 June 1996, the United States has since become a signatory to this treaty. The World Bank’s chairman, James Wolfensohn, has spoken out on corruption and is expected to make it an important point in his speech to the World Bank’s meeting later this year. Already the World Bank’s board has approved reforms in the procurement process. On 23 July 1996, the Board of the World Bank adopted requirements that all commissions paid to agents be disclosed to the World Bank, giving the Board the right to audit contractors and suppliers, and strengthened provisions for cancellation of bribe-tainted contracts and for debarment from contracting of violators. The International Monetary Fund is exploring steps that it might take. The Council of Securities Regulators of the Americas (COSRA) adopted an anti-bribery resolution to ensure enforcement of and compliance with internal control and accurate books and records requirements. COSRA also agreed to facilitate closer cooperation among securities and banking regulators in investigations and in criminal prosecutions for bribery. The United States, in conjunction with other members of the United Nations (UN), has drafted a proposed UN declaration for consideration at the ECOSOC General Assembly meeting in fall 1996 to support the efforts of the OAS, OECD and to criminalize bribery and repeal laws allowing foreign bribes to be tax deductible. Another group committed to the issue is Transparency International (Tl). TI leads an international effort to curb corruption. It spreads the message throughout the world that there is an underlying logic to reducing corruption; that, if countries want to enjoy the benefits of growing foreign investment in flourishing trade, they must clean up their corrupt practices. It advocates that corporations and governments throughout the world should discontinue

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practices which encourage corruption; that they should place sanctions on both those who give and those who take bribes. The United States chapter of TI is supported by a growing number of prominent businesspeople and corporations, all of whom have recognized that corruption abroad can indeed be fought if major foreign and US companies join forces to discourage corruption and support the “rule of law.” While all of these efforts are encouraging to the writer of this chapter (who worked at the SEC in the 1970s during the infancy of the fight against foreign corruption and helped with the FCPA), the reality is that these efforts remain largely aspirational and greatly in need of support by action.

OECD Convention The OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions creates an international anti-bribery system that obligates signatory countries to enact domestic laws to combat foreign bribery. •

The United States, which has had such a law since 1977, will no longer be alone once the Convention is ratified and implemented by the parties. • Thirty-three countries have joined this historic Convention. Those countries included the 29 OECD members (United States, UK, Japan, Canada, France, Germany, Italy, Korea, Mexico, Switzerland, Australia, Austria, Belgium, Czech Republic, Denmark, Finland, Greece, Hungary, Iceland, Ireland, Luxembourg, The Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, and Turkey) and five other nations (Argentina, Brazil, Bulgaria, Chile, and the Slovak Republic). • The OECD Convention will level the international trade playing field since our major trading partners are now obligated to enact foreign anti-bribery laws.

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Similarly to the Foreign Corrupt Practices Act (FCPA), the OECD Convention: •

• • •

provides that parties shall make it a crime “for any person intentionally to offer, promise or give any undue pecuniary or other advantage ... to a foreign public official ... in order to obtain or retain business or other improper advantage in the conduct of international business;” applies to corrupt payments to office-holders, legislators, and personnel of government-controlled companies (so-called “parastorels”); recognizes an exemption for small “facilitating payments;” and requires parties to enact accounting requirements for the purpose of preventing false or misleading accounting practices that can be used to bribe or hide such bribery.

In order to ensure full and effective implementation, the OECD Convention also requires that the parties to the OECD Convention: •

review their current basis for jurisdiction and take remedial steps if they are not effective in the fight against bribery; • consult when more than one party asserts jurisdiction; • provide legal assistance to each other relating to investigations and proceedings and make bribery of foreign officials an extraditable offense; and • cooperate in a follow-up program in the OECD to monitor compliance with the Convention. The parties to the OECD Convention have already agreed to an accelerated work plan to address several outstanding issues related to the Convention, including acts of bribery relating to foreign political parties, and coverage of foreign subsidiaries.

Transnational Efforts The US has led the charge against bribery and corruption on several fronts. Efforts have been made to stop transnational bribery on both the “supply”

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and “demand” side of the problem, making it disadvantageous for companies to pay bribes as well as making it difficult for those awarding contracts to be influenced by bribes when doing business. The US has also supported initiatives in various institutions, such as the WTO, the Organization of American States (OAS), Asia Pacific Economic Cooperation (APEC) and the UN. On the supply side of the equation, a key obstacle has been that no other country specifically outlaws foreign corruption. US firms have been prohibited from bribing foreign officials since 1977 under the FCPA. Other countries have not yet followed suit, although a few countries have stated publicly that their existing criminal statutes can cover bribery abroad. As a result, many of the US trading partners’ domestic corporations are legally able to pay bribes to foreign officials while American companies cannot. The US launched its first efforts to multilateralize prohibitions on transnational bribery in the OECD shortly after the 1977 passage of the FCPA. After unsuccessful attempts in the 1980s to develop meaningful disciplines building on an anti-bribery provision in the OECD’s Guidelines on Multinational Enterprises, the United States proposed negotiation of an international agreement in the OECD on the prohibition of overseas bribes (as mandated by the 1988 Trade Act). In 1993, the Clinton Administration elevated US efforts to secure action in the OECD by involving high-level officials from the State and Treasury Departments. The United States sponsored the 1994 OECD Recommendation on Bribery in International Business Transactions that calls on member states to “take concrete and meaningful steps” to deter, prevent, and combat bribery of foreign public officials. The first significant OECD steps on bribery came to fruition at the May 1996 Ministerial Conference. First, the OECD adopted the Recommendation on Tax Deductibility of Bribes to Foreign Public Officials, which calls on members that allow the tax deductibility of bribes to “reexamine such treatment with the intention of denying this deductibility” (more than half of the OECD member states treat international bribery as a business expense, hence consider it tax deductible). Second, OECD ministers made a political commitment to criminalize bribery “in an effective and coordinated manner,” and to examine the “modalities and appropriate international instruments to facilitate criminalization and consider proposals in 1997.”

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Next steps at the OECD are forming the basis for a Secretariat report to the May 1997 OECD Ministerial. The outcome of that process will be the agreement on principles for criminalization and means to implement those principles. At the June 1996 Lyon Summit, our OECD efforts were reinforced when the G7 resolved to combat corruption in international business transactions through supporting ongoing efforts in other multilateral organizations. On the demand side of the problem, the efforts were made to implement a new OAS convention criminalizing transnational bribery and to implement the anti-corruption certification process included in financing supported by the North American Development Bank (NADBank). Recent success in the OAS on an Inter-American Convention Against Corruption indicates bribery is a problem of concern not only to the US — it is a hemispheric issue that other OAS countries also recognize as a priority. The Convention, which came about as a result of the 1994 Summit of the Americas Plan of Action, was completed in March 1996. It has been signed by 23 of the total 35 OAS member states, but has not yet been ratified by any country. Among other achievements, it is the world’s first anti-corruption treaty which requires signatories to criminalize bribery of foreign officials. Signatories must update their domestic legislation to criminalize a set of specific corrupt acts related to bribery and illicitly obtained benefits. Cooperation among signatories is strengthened on extradition, mutual legal assistance, and asset forfeiture for corruption-related crimes. While the Convention does not set specific deadlines for implementation of these commitments, discussion is already underway on ways to help member countries rewrite laws and regulations to comply and technical and other assistance to facilitate the process. The OAS Secretary General is required to report to next summer’s General Assembly on member countries’ progress in adopting and implementing required changes. In the NAFTA-created NADBank, the US successfully won agreement from its NAFTA partner Mexico in 1996 that its guidelines require companies to certify that they have not engaged in bribery of foreign or domestic officials in projects funded by NADBank. Companies must also have corporate policies that prohibit bribery and must assert that they have not

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been convicted of bribery within five years of the certification. If NADBank discovers that a company has been convicted of bribery, it may debar that company from future participation in a NADBank-funded or guaranteed project. Secretary Rubin has urged that the Multilateral Development Banks (MDBs), including regional banks, press for similar procedures in the projects that they fund or guarantee. Membership in the new WTO Government Procurement Agreement (GPA), which took force on 1 January 1997 is voluntary rather than mandatory for WTO members. Signatories are predominantly industrialized countries, including the United States, Canada, the EU member states, Israel, Japan, Norway, the Republic of Korea, and Switzerland. The United States is continuing to encourage individual countries to accede to the GPA with negotiations now ongoing with Singapore and Taiwan, but most WTO members have indicated that they are not ready because its strict disciplines would require substantial changes in domestic laws and procedures. As a result, many key markets in Asia, the Americas, Eastern and Central Europe, and Africa are not subject to the rigorous disciplines of the GPA. Estimates of the value of procurement markets in these countries are in the trillions of dollars. To move more countries toward implementing government procurement reforms and eventual commitment to the GPA, the United States and some other major trade players have agreed to seek consensus at the Singapore Trade Ministerial on a mandatory WTO interim procurement accord including disciplines on transparency, openness, and due process. This understanding was reached at the Kobe Ministerial this April among the Quad countries (the US, Japan, EU, and Canada), and reiterated at the G-7 Ministerial in July. Disciplines may include publicizing procurement opportunities, setting out specific evaluation criteria, awarding of contracts strictly on the basis of specified criteria, and providing access to independent review bodies to challenge procurement decisions. In the Asia Pacific Economic Cooperation Forum (APEC) and the Free Trade Area of the Americas (FTAA), we are opening a dialogue with developing countries on transparency and accountability on procurement and, in the process, building a consensus for a WTO initiative prior to the Singapore Ministerial. The Action Plan of the Summit of the Americas calls on the “governments of the world to adopt and enforce measures against

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bribery in all financial or commercial transactions within the Hemisphere.” APEC’s Osaka Action Agenda called on member economies to achieve transparency in their procurement laws and procedures. After the Ministerial, efforts in these regional groups are intended to complement the WTO work. In the United Nations, the US introduced a proposal for a “United Nations Declaration on Corruption and Bribery in Transnational Commercial Activities” at the July 1996 session of the UN Economic and Social Council, which calls on member states to criminalize bribery (domestic or transnational) and prohibit tax deductibility of bribes. The US has also played an instrumental role in the development of a Model Procurement Law of the United Nations Commission on International Trade Law (UNCITRAL). The Law is designed to promote transparency and objectivity in public procurement proceedings; it specifically requires the rejection of a tender, proposal, offer, or quotation if it is accompanied by a bribe from a supplier or contractor. Most recently, Poland and Albania adopted the law and a number of other countries are considering its implementation. The US has pursued an aggressive anti-bribery strategy through the Multilateral Development Banks (MDBs) to strengthen guidelines for procurement in contracts they finance. In 1995, the World Bank revised its procurement rules for goods and works to strengthen transparency, mandate the use of standard bidding documents, incorporate written guidance to bidders, and tighten and clarify bidding procedures. These revisions are safeguards against bribery and corruption, and are supplemented by ongoing Bank training and technical assistance for member governments’ contracting officials and auditors. This year the World Bank took additional action against bribery by explicitly stating that it is the Bank’s policy not to tolerate fraud or corruption on Bank-financed contracts by bidders or borrowers. Anti-bribery amendments to the World Bank’s loan conditions, procurement rules, and standard bidding documents were approved in July 1996. The amendments require disclosure of commissions and gratuities paid or to be paid to agents relating to their bids or to contract execution on World Bank-financed contracts. Sanctions were incorporated into the procurement rules. The Bank will reject proposals for contract award or cancel the portion of the loan if the bidder or the borrower has engaged in fraud or corruption in

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the procurement or execution of the contract. Companies determined by the Bank to have engaged in corrupt or fraudulent practice will be blacklisted from participation in Bank-financed contracts, either indefinitely or for a stated period of time. These amendments are major steps forward. World Bank management has also proposed three interrelated, constructive approaches to controlling corruption through (1) economic policy reforms in developing countries, (2) institutional reforms in developing countries, and (3) the Bank’s fiduciary responsibility on its projects. These approaches will be more fully explored in discussions with the Board later this year. Simultaneously, we are pressing the Bank to enhance its supervision of procurement through increased procurement staffing, more rigorous headquarters review of procurement, limited delegation of procurement oversight to field offices, and comprehensive one-stop advertising. The World Bank procurement reforms reflect useful interchange on the corruption issue between Bank management and US business community representatives, as well as with US government officials. An exchange of letters between the President of the World Bank and the Chairman of the Business Roundtable’s International Trade and Investment Task Force has helped inform World Bank staff efforts in preparing amendments to procurement guidelines and bidding documents. The Development Committee of the World Bank and the International Monetary Fund addressed international bribery as part of its major examination begun in late 1994. In a report released in March 1996, the Development Committee Task Force emphasized the MDBs’ important role in helping member countries create and maintain an environment of effective government and a strong civil society, including a reliable framework of rules and institutions. The report recommended that MDBs coordinate procurement policies and rules. In the United States, Treasury Secretary Rubin has strongly endorsed this task force recommendation and has urged its incorporation into the ongoing reform efforts now underway at all of the multilateral development banks. He has underscored the need for the institutions to establish uniform procurement rules harmonized to the highest standard, the required use of standard bidding documents, strong headquarters oversight of the procurement process, and address transnational bribery on a collaborative basis.

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Appendix 4 OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions Adopted by the Negotiating Conference on 21 November 1997 Preamble The Parties, Considering that bribery is a widespread phenomenon in international business transactions, including trade and investment, which raises serious moral and political concerns, undermines good governance and economic development, and distorts international competitive conditions; Considering that all countries share a responsibility to combat bribery in international business transactions; Having regard to the Revised Recommendation on Combating Bribery in International Business Transactions, adopted by the Council of the Organisation for Economic Cooperation and Development (OECD) on 23 May 1997, C(97)123/FINAL, which, inter alia, called for effective measures to deter, prevent and combat the bribery of foreign public officials in connection with international business transactions, in particular the prompt criminalisation of such bribery in an effective and coordinated manner and in conformity with the agreed common elements set out in that Recommendation and with the jurisdictional and other basic legal principles of each country; Welcoming other recent developments which further advance international understanding and cooperation in combating bribery of public officials, 343

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including actions of the United Nations, the World Bank, the International Monetary Fund, the World Trade Organization, the Organization of American States, the Council of Europe and the European Union; Welcoming the efforts of companies, business organisations and trade unions as well as other nongovernmental organisations to combat bribery; Recognizing the role of governments in the prevention of solicitation of bribes from individuals and enterprises in international business transactions; Recognizing that achieving progress in this field requires not only efforts on a national level but also multilateral cooperation, monitoring and follow-up; Recognizing that achieving equivalence among the measures to be taken by the Parties is an essential object and purpose of the Convention, which requires that the Convention be ratified without derogations affecting this equivalence; Have agreed as follows: Article 1 The Offence of Bribery of Foreign Public Officials 1. Each Party shall take such measures as may be necessary to establish that it is a criminal offence under its law for any person intentionally to offer, promise or give any undue pecuniary or other advantage, whether directly or through intermediaries, to a foreign public official, for that official or for a third party, in order that the official act or refrain from acting in relation to the performance of official duties, in order to obtain or retain business or other improper advantage in the conduct of international business. 2.

Each Party shall take any measures necessary to establish that complicity in, including incitement, aiding and abetting, or authorization of an act of bribery of a foreign public official shall be a criminal offence. Attempt and conspiracy to bribe a foreign public official shall be

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criminal offences to the same extent as attempt and conspiracy to bribe a public official of that Party. 3.

The offences set out in paragraphs 1 and 2 above are hereinafter referred to as “bribery of a foreign public official.”

4. For the purpose of this Convention: a. “foreign public official” means any person holding a legislative, administrative or judicial office of a foreign country, whether appointed or elected; any person exercising a public function for a foreign country, including for a public agency or public enterprise; and any official or agent of a public international organization; b.

“foreign country” includes all levels and subdivisions of government, from national to local;

c.

“act or refrain from acting in relation to the performance of official duties” includes any use of the public official’s position, whether or not within the official’s authorised competence. Article 2 Responsibility of Legal Persons

Each Party shall take such measures as may be necessary, in accordance with its legal principles, to establish the liability of legal persons for the bribery of a foreign public official. Article 3 Sanctions 1. The bribery of a foreign public official shall be punishable by effective, proportionate and dissuasive criminal penalties. The range of penalties shall be comparable to that applicable to the bribery of the Party’s own public officials and shall, in the case of natural persons; include deprivation of liberty sufficient to enable effective mutual legal assistance and extradition.

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2.

In the event that, under the legal system of a Party, criminal responsibility is not applicable to legal persons, that Party shall ensure that legal persons shall be subject to effective, proportionate and dissuasive noncriminal sanctions, including monetary sanctions, for bribery of foreign public officials.

3.

Each Party shall take such measures as may be necessary to provide that the bribe and the proceeds of the bribery of a foreign public official, or property the value of which corresponds to that of such proceeds, are subject to seizure and confiscation or that monetary sanctions of comparable effect are applicable.

4. Each Party shall consider the imposition of additional civil or administrative sanctions upon a person subject to sanctions for the bribery of a foreign public official. Article 4 Jurisdiction 1. Each Party shall take such measures as may be necessary to establish its jurisdiction over the bribery of a foreign public official when the offence is committed in whole or in part in its territory. 2. Each Party which has jurisdiction to prosecute its nationals for offences committed abroad shall take such measures as may be necessary to establish its jurisdiction to do so in respect of the bribery of a foreign public official, according to the same principles. 3. When more than one Party has jurisdiction over an alleged offence described in this Convention, the Parties involved shall, at the request of one of them, consult with a view to determine the most appropriate jurisdiction for prosecution. 4. Each Party shall review whether its current basis for jurisdiction is effective in the fight against the bribery of foreign public officials and, if it is not, shall take remedial steps.

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Article 5 Enforcement Investigation and prosecution of the bribery of a foreign public official shall be subject to the applicable rules and principles of each Party. They shall not be influenced by considerations of national economic interest, the potential effect upon relations with another State or the identity of the natural or legal persons involved. Article 6 Statute of Limitations Any statute of limitations applicable to the offence of bribery of a foreign public official shall allow an adequate period of time for the investigation and prosecution of this offence. Article 7 Money Laundering Each Party which has made bribery of its own public official a predicate offence for the purpose of the application of its money laundering legislation shall do so on the same terms for the bribery of a foreign public official, without regard to the place where the bribery occurred. Article 8 Accounting 1. In order to combat bribery of foreign public officials effectively, each Party shall take such measures as may be necessary, within the framework of its laws and regulations regarding the maintenance of books and records, financial statement disclosures, and accounting and auditing standards, to prohibit the establishment of off-the-books accounts, the making of off-the-books or inadequately identified transactions, the recording of non-existent expenditures, the entry of liabilities with

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incorrect identification of their object, as well as the use for the purpose of bribing foreign public officials or of hiding such bribery. 2. Each Party shall provide effective, proportionate and dissuasive civil administrative or criminal penalties for such emissions and falsifications in respect of the books, records, accounts and financial statements of such companies. Article 9 Mutual Legal Assistance 1. Each Party shall, to the fullest extent possible under its laws and relevant treaties and arrangements, provide prompt and effective legal assistance to another Party for the purpose of criminal investigations and proceedings brought by a Party concerning offences within the scope of this Convention and for non-criminal proceedings within the scope of this Convention brought by a Party against a legal person. The requested Party shall inform the requesting Party, without delay, of any additional information or documents needed to support the request for assistance and, where requested, of the status and outcome of the request for assistance. 2. Where a Party makes mutual legal assistance conditional upon the existence of dual criminality, dual criminality shall be deemed to exist if the offence for which the assistance is sought is within the scope of this Convention. 3. A Party shall not decline to render mutual legal assistance for criminal matters within the scope of this Convention on the ground of bank secrecy. Article 10 Extradition 1.

Bribery of a foreign public official shall be deemed to be included as an extraditable offence under the laws of the Parties and the extradition treaties between them.

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2. If a Party which makes extradition conditional on the existence of an extradition treaty receives a request for extradition from another Party with which it has no extradition treaty, it may consider this Convention to be the legal basis for extradition in respect of the offence of bribery of a foreign public official. 3. Each Party shall take any measures necessary to assure either that it can extradite its nationals or that it can prosecute its nationals for the offence of bribery of a foreign public official. A Party which declines a request to extradite a person for bribery of a foreign public official solely on the ground that the person is its national shall submit the case to its competent authorities for the purpose of prosecution. 4.

Extradition for bribery of a foreign public official is subject to the conditions set out in the domestic law and applicable treaties and arrangements of each Party. Where a Party makes extradition conditional upon the existence of dual criminality, that condition shall be deemed to be fulfilled if the offence for which extradition is sought is within the scope of Article 1 of this Convention. Article 11 Responsible Authorities

For the purposes of Article 4, paragraph 3, on consultation, Article 9, on mutual legal assistance and Article 10, on extradition, each Party shall notify to the Secretary-General of the OECD an authority or authorities responsible for making and receiving requests, which shall serve as channel of communication for these matters for that Party, without prejudice to other arrangements between Parties. Article 12 Monitoring and Follow-up The Parties shall cooperate in carrying out a programme of systematic followup to monitor and promote the full implementation of this Convention. Unless otherwise decided by consensus of the Parties, this shall be done

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in the framework of the OECD Working Group on Bribery in International Business Transactions and according to its terms of reference, or within the framework and terms of reference of any successor to its functions, and Parties shall bear the costs of the programme in accordance with the rules applicable to that body. Article 13 Signature and Accession 1. Until its entry into force, this Convention shall be open for signature by OECD members and by non-members which have been invited to become full participants in its Working Group on Bribery in International Business Transactions. 2. Subsequent to its entry into force, this Convention shall be open to accession by any nonsignatory which is a member of the OECD or has become a full participant in the Working Group on Bribery in International Business Transactions or any successor to its functions. For each such non-signatory, the Convention shall enter into force on the sixtieth day following the date of deposit of its instrument of accession. Article 14 Ratification and Depositary 1. This Convention is subject to acceptance, approval or ratification by the signatories, in accordance with their respective laws. 2. Instruments of acceptance, approval, ratification or accession shall be deposited with the Secretary-General of the OECD, who shall serve as Depositary of this Convention. Article 15 Entry into Force 1. This Convention shall enter into force on the 60th day following the date upon which five of the ten countries which have the ten largest

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export shares set out in DAFFE/IME/BR(97)18/FINAL (annexed), and which represent by themselves at least 60 percent of the combined total exports of those ten countries, have deposited their instruments of acceptance, approval, or ratification. For each signatory depositing its instrument after such entry into force, the Convention shall enter into force on the sixtieth day after deposit of its instrument. 2. If, after 31 December 1998, the Convention has not entered into force under paragraph I above, any signatory which has deposited its instrument of acceptance, approval or ratification may declare in writing to the Depositary its readiness to accept entry into force of this Convention under this paragraph 2. The Convention shall enter into force for such a signatory on the 60th day following the date upon which such declarations have been deposited by at least two signatories. For each signatory depositing its declaration after such entry into force, the Convention shall enter into force on the 60th day following the date of deposit. Article 16 Amendment Any Party may propose the amendment of this Convention. A proposed amendment shall be submitted to the Depositary which shall communicate it to the other Parties at least 60 days before convening a meeting of the Parties to consider the proposed amendment. An amendment adopted by consensus of the Parties, or by such other means as the Parties may determine by consensus, shall enter into force 60 days after the deposit of an instrument of ratification, acceptance or approval by all of the Parties, or in such other circumstances as may be specified by the Parties at the time of adoption of the amendment. Article 17 Withdrawal A Party may withdraw from this Convention by submitting written notification to the Depositary. Such withdrawal shall be effective one year after the date

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of the receipt of the notification. After withdrawal, cooperation shall continue between the Parties and the Party which has withdrawn on all requests for assistance or extradition made before the effective date of withdrawal which remain pending.

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b2530   International Strategic Relations and China’s National Security: World at the Crossroads

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INDEX

A a 15 percent alliance, 310 adaptive diversification, 184 advertising, 62, 86, 89, 124, 138–139, 167–168, 185, 311, 342 affinal guanxi, 5 ai, 13, 28 Airbus, 198–200 Al Gore, 38 alliance, 7, 46, 152, 182–183, 186–188, 211, 242, 310 Alston, 33, 45, 116, 189 American Home Products, 307 Anderson, Arthur, 73–75 anti-bribery, 30, 275, 323, 326–327, 334–336, 338, 341 anti-bribery laws, 313, 323, 336 anti-corruption, 205, 213–214, 218, 245–247, 252, 255, 262, 264–267, 270–274, 276, 313, 323, 333–334, 339 Anti-Corruption Bureau, 213 anti-corruption campaign, 212, 233, 316 Anti-Corruption Reporting Center, 212 Anti-Trust Law, 167 appraisal committees, 321 ASEAN, 68 Asia Pacific Economic Cooperation (APEC), 338, 340

Aufrecht, 24 Avon, 7 B BAIC, 72 Banfield, 237 banqueting, 59, 316 Barney, 86, 116, 118, 123, 235 barter, 28 bifurcation of ownership and management, 5 big six, 73–74 bilateral negotiation, 19 black corruption, 204 black market, 28, 227, 319 blood bases, 6 blood guanxi, 297 Boeing, 38, 197–199 Boisot, 47, 82, 100, 114, 118 Booz-Allen and Hamilton, 308 boundary blurring, 82 boundary spanners, 146–148 Bourdieu, 43 brand competition, 178 bribe, vi, 11, 26, 29–30, 35, 41, 44, 205–206, 211, 214, 217–218, 226–231, 245–246, 253–254, 257– 258, 261, 264–265, 275, 285, 316, 330, 333, 335–338, 341, 344–346 369

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370   Index

bribery, 28–30, 35, 41, 52, 211–212, 216, 218–219, 225–226, 228, 232–237, 245–247, 250–251, 256, 259–261, 263–266, 274–275, 285, 313–315, 320, 323, 326, 329–331, 333–350 bribery statute, 326 British East India Company, 68 Britton, 71–73 Brooks, 204 Buckley, 188 Buddhism, 30 Bun, 24 Bunker, 232 bureaucracy, 23, 45, 50–51, 58, 215–217, 225, 227, 237 bureaucratic control, 23–24 bureaucratic corruption, 205, 216, 218, 224–225, 237 Burt, 83, 86 business associations, 58 business ethics, 30, 169, 221, 236, 249, 254, 260, 267, 273–274 business stakeholders, 95 Butterfield, 8 bu zheng zhi feng, 316 C Casson, 188 Carlyle Asia Partners, L.P., 103 categorical malfeasance, 259, 261–263, 273 Cathay Pacific Airways Ltd, 198 Central Audit Bureau, 319 Central Commission for Discipline Inspection in Beijing, 212 Charoen Pokphand, 151 Chase Capital Partners, 101

b3718_Index.indd 370

Chase Manhattan Bank, 102 Chauvin, 138 Chavkin, Arnold, 101–103 Chen, 33–34, 46, 84, 91, 98, 105, 124, 138, 142, 319 Chen Xitong, 212 Child, 47–48, 59, 82, 100, 114, 118 China Construction Bank, 106 China Economic Development Corporation, 319 China Everbright-IHD, 106–107 China Hewlett-Packard, 193 China International Economic Consultants (CIEC), 74–75 China International Trust & Investment Corporation (CITIC), 74, 103, 310, 319 China Venture Advisors, 150 China Venturetech, 105 Chinese bureaucracy, 45, 84–85, 300 Chinese Communist Party, 104, 213 Chinese cultural values, 24 Chinese partner, 130, 133–134, 182, 187, 304 Chinese stock market, 239–240 Chinese triangle, 131 Chu Shijian, 26, 276–282 ci hai, 2 Citic Pacific, 103–105 ci yuan, 2 Coase, 228 Cohen, 77, 232 collectivist culture, 62, 145, 290 Company Law, 169 competence building, 177, 185 competence complementarity, 64 competence enabling, 81 competence transfer, 177

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Index   371

competitive advantage, 52, 55–56, 61, 83, 86, 118, 123, 138, 162, 221, 232, 235–236 competitive disadvantage, vii, 123, 203, 236, 334 competitive landscape, 160, 186 complementary capabilities, 66, 184 complementary resources, 54, 64, 181, 187 compliance program, 270–272 compliance system, 264, 267 conduct code, 267 configuration approach, 119–120 Confucian, Daoist, 30 Confucian ethic, 60 Confucianism, 7–8, 13, 24, 145 Confucian legacy, 7 Confucian social theory, 13 Confucian societies, 11, 31 connection, 2–3, 11, 15–16, 22–23, 31, 33, 38–43, 45–47, 70, 73, 77, 83–85, 90, 99, 102–107, 115–116, 118, 122–123, 127–128, 134, 195, 200, 207, 209, 221, 233, 260, 274, 280, 287, 300, 310–311, 318, 328, 343 connectivity, 51, 58–59 consultation, 19, 148, 349 contextual, 3, 11, 91, 98, 100, 205, 290 contractual liability lever, 12, 118 Coopers & Lybrand, 74 coopetition, 181–183 corporate bribery, 234, 236 corporate culture, 3, 36, 235, 250, 264–265, 307 corporate governance, ix, 7, 238–247 corporate social responsibility, 221

b3718_Index.indd 371

corruption, vii, 26, 30, 32, 84, 96, 98, 100–101, 200, 203–220, 222–229, 231–239, 243, 245–265, 267–268, 270–277, 282–287, 307, 313, 316–317, 319–320, 330, 334–339, 341–342 corruption distorted incentives, 226 corruption transactions, 230–231 Council of Europe, 344 Council of Securities Regulators of the Americas, 335 credibility, vii, 6, 15, 17–18, 36, 148, 180, 210, 236, 238, 274, 289, 298–300 credit-extension, 139, 141 credit liberalization, 98, 124, 138–139 Credit Lyonnais Securities Asia, 106 criminal fraud, 210, 217, 233 Crimson Asia Capital Holdings Ltd, 102 critical capability, 54, 57 cross-organizational connections, vi, 111–112 cultural capital, 44–45 cultural norms, 25 culture gap, 151 Cummings, 113 current ratio, 86 custom, 26, 133, 269–270, 329 Cyert, 79 D Daniel Lam, 130 danwei, 22 daoqie, 313–314 David Li, 7 Davies, 34

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372   Index

de, 30 degraded morality, 219 Deloitte Touche Tohmatsu, 74 demoralization, 219–220, 222, 224 Department of Justice, 330 developed growth markets, 163 Dexter Roberts, 39 discretionary power, 51 domestic bribery statute, 324–325 domestic concern, 323 Downs, Anthony, 237 E economic capital, 43–44 economic life, 26, 32 economic rent, vi, 43, 54, 232, 291 economic value, 43, 97, 298, 300, 326 educational investment, 176–177 efficacy, 51 efficiency-oriented firms, 121 efficiency-oriented strategy, 120–121 Ekpo, 204 embezzlement, 211–212, 216, 313, 317, 320 enforcement, 30, 32, 60, 84, 144, 169, 207, 218, 221, 226, 268, 270, 331, 335, 347 Engels, 216 entrepreneur, 50–51, 57–59, 302, 304 environmental uncertainty, 28, 79, 85, 117 equity joint ventures, 171 Ernst & Young, 73 ethically apathetic, 219 European Union, 201, 344 executive compensation, 81, 241–242

b3718_Index.indd 372

external legitimacy, 48 external ties, 81, 122 extradition, 339, 345, 348–349, 352 F fa, 31 face, 10, 13–15, 27, 31, 39, 46–47, 52, 54, 56, 59, 62, 72, 77, 85, 118, 120–122, 140, 145, 147–148, 160, 165, 172, 181, 185, 208, 223–224, 240, 246, 260–261, 274, 287, 290, 293, 320, 327 facilitating payments, 328 family-centered relationship, 244 Farh, 10, 115 favoritism, 9, 216 favors, vi, 2, 4, 10, 12, 15–16, 18, 20–21, 24, 27, 39, 44, 54, 59, 70, 111, 128, 146, 190, 207–208, 210, 222, 227, 281, 290–292, 298, 316 feng shui, 153 Fictive kinship, 5 firm performance, vi, 1, 33–34, 36, 55, 61, 79, 81–92, 94–101, 111, 138, 143–145, 221, 234–235, 290 firm size, 88, 96, 122, 138–139, 173, 192 Fok, 39–40 Ford, 175, 186 Foreign Corrupt Practices Act (FCPA), 41, 247, 269–270, 323–330, 333–338 foreign direct investment (FDI), vii, 63, 65, 67–69, 71, 142, 157, 164–166, 168, 170–171, 186, 188–189, 201, 219, 225

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Index   373

foreign-invested enterprises, 61, 82, 159, 169, 190–191 foreign investors status, 158 foreign official, 324–326, 328–330, 333 foreign-owned subsidiary, 188 foreign public official, 337, 344–349 foreign subsidiaries, 248, 324, 337 fortune, 40, 71, 193–194, 331 Freeman, 124 Free Trade Area of the Americas (FTAA), 340 Friedrich, 204 friendship, 2, 6, 9–10, 16, 23, 35, 224 Friesen, 120 Frost & Sullivan, 150 Fuji Xerox, 187 G G-7, 340 gain, vii, 9, 29, 35, 49, 55, 58, 71–73, 90, 95, 97, 113–114, 137, 139, 141, 145, 157, 189, 192, 206, 222, 240, 303, 333 Galaskiewicz, 112–113 Gallego, 138 game theory, 209 ganqing, 6, 15–16, 19, 29, 35, 55–56 Gates, 25 Geletkanycz, 81 General Chi Haotian, 38 General Motors, 71, 73, 301 geographic affinity, 67 geographical migration, 24 George Bush, 152 Germany, 333, 336

b3718_Index.indd 373

gift, 11, 26–29, 58, 147, 265, 324–327, 329–330 gift exchange, 28–29 gift-giving, 11, 26–29, 31, 52, 58–59, 206, 208, 214–215, 251, 274, 298, 317 global restructuring, 187 GM, 171, 187–188, 301–305 GM–China Technology Institutes, 303 Goes, 17, 80–81, 114, 150, 201, 211, 224 Gong, 204 Gore, Albert, 38, 302, 304 good faith, 62, 145, 290, 330 governmental guanxi, 128 government authority, vii, 32, 88, 90, 94, 96, 111–112, 119, 127–128, 166, 170, 233, 254, 257, 291, 295, 297 government ties, 95 Granovetter, 33 Greenspan, Alan, 38 grease payments, 229 grey corruption, 204 gua guanxi, 12 guan, 2 guan huai, 2 guanxi, v–viii, 1–63, 70–72, 76–77, 79, 81–85, 87–99, 101–102, 104, 106–107, 111–112, 114–118, 120–129, 132–135, 137–151, 154, 157, 188–192, 194, 197, 199–200, 203, 206–210, 217, 222–224, 232, 234, 238, 242–243, 286, 289–291, 293–301, 306–308, 310 guanxi alliance, 311 guanxi base, 4–7, 15–16, 19, 55

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b3718   Guanxi and Business 6"×9"

374   Index

guanxi capital investments, 57 guanxi concepts & principles, 20 guanxi connections, vii, 3, 11, 18, 26–27, 30, 48, 55, 71, 74, 103, 107, 119, 126, 209, 289, 296, 298–299 guanxi cultivation, vi–vii, 1, 3, 10, 25, 27, 29, 45, 86, 111, 121–122, 124, 157, 289, 295 guanxi dynamics, v–vi, 1, 34 Guanxi gou qiang, 12 guanxi hu, 12, 22, 46–47, 71, 112, 137–138, 140–141, 190 guan xin, 2, 59 guanxi network, vi–vii, 1, 5, 12–15, 23, 32, 34–35, 47, 52–53, 62, 70–71, 79–81, 83, 86, 111, 114–116, 118–128, 137–142, 145, 157, 188–190, 192, 197, 217, 223, 289–290, 292, 295–298 guanxi partners, 10, 18–19, 23, 25, 46, 54–55 guanxi utilization, vi, 34, 96, 111–112, 115–116, 125–126, 128–129 Guanxiwang, 12, 26, 217 guanxi web, 142, 190 Guanxi xue, 4 guan zhao, 2 Gulati, 83 H hai guan, 2 Hall, 122, 138 Hambrick, 81 Hamel, 123 Hamilton, 121 Han Dynasty, 68

b3718_Index.indd 374

Hang Lung Properties, 152 Hannan, 124 Harianto, 80 Harlan Sanders, 129 he, 13 Heublin Inc. 129 Heath, 46, 82, 100, 117 Henry Fok, 39–40 Hewlett-Packard, 192–197 Hirschey, 138 Hitachi, 187 HKR International, 105 Hong, 306–308 Hongta Group, 279–280 Hoskinsson, 138 Huaneng International Power, 105 hukou, 24 Hwang, 15, 21, 25, 148 H-shares, 239 I IBM, 180, 182 implicit collusion, 83 individual guanxi, vii, 295, 297 individualism, 73 Indonesia, 68, 129, 198, 211, 302 informal social institutions, 220 in-group favoritism, 9 in-group members, 8 institutional anomie, 220 institutional complexity, 252, 255, 257–258 institutional factors, 117, 127 institutional fairness, 252, 255–256 institutional legitimacy, 36, 116, 124 institutional transparency, 252, 255–256, 258, 263

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b3718   Guanxi and Business

Index   375

institutionalized guanxi, 6 intangible, 10, 14, 86, 126 Inter-American Convention Against Corruption, 335, 339 interdependent self, 8 inter-firm collaboration, 83 inter-firm exchange, 146–147 inter-firm guanxi, 112 inter-firm networking, 2, 12 inter-firm relations, 5 interlocking directorate, 242–243 intermediary, vii, 7, 16, 36, 53, 96, 210, 265, 268, 289, 292–293, 344 International Chamber of Commerce (ICC), 334 International Finance Corp, 101 International Monetary Fund, 225, 335, 342, 344 interpersonal guanxi, 57, 79, 83 interpersonal linkages, 2 interpersonal relationship, v, 1–3, 9, 47, 224 interpersonal ties, 48, 81–82, 100–101, 146 interpersonal trust, 18 interorganizational ties, 80, 82 intertwineability, 32, 222–224 intra-regional FDI, 67 iron rice bowl, 12 issuer, 323 J James Clarke, 106 James Scott, 227 James Wolfensohn, 335 Jiang Zemin, 214

b3718_Index.indd 375

Jiangshu Zhenhua Chemical Industrial Corporation, 319 jia-ren, 8–9, 223 Jinbei Automotive, 302, 304 Johnson, 138 joint venture, 18, 34, 57, 71, 73–75, 130–131, 133, 150–151, 162, 166, 172, 174–175, 182, 187–188, 191, 193, 196, 201, 209, 275, 301–308, 310, 324 Joint Venture Law, 166 Ju, 26 jurisdiction, 269, 284, 292, 315, 318, 337, 346 Justin Doebele, 41 K Kang Hua Development Corporation, 319 Kao, 33, 45, 83, 115, 189–190 kexin, 18–19, 299–300 KFC, 129–130, 185 kickbacks, 57, 214, 218, 246, 315 kinship, 2, 4–5, 23, 35, 224, 227, 289 kinship guanxi, 5, 9 Kleptocrats, 333 Kohler Company, 150 Koll, 151–153 L La guanxi, 12, 20, 27 leapfrog, 310 leapfrog alliance, 310–311 learning effect, 191 legal codes, 204, 206, 217, 313 Levine, 113

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b3718   Guanxi and Business 6"×9"

376   Index

li, 30–31 lianxi, 306 lianzheng, 57 Linder’s model of international economics, 66 Li Keqiang, 200–201 Li Peng, 75, 105, 134, 198, 302, 304 Li shun guanxi, 12 locality, 5, 289 local partner, 102, 184, 188, 191, 201, 90, 304 losing face, 14, 29 loyalties cluster, 9 lun, 7, 13 Luo, viii–ix, 33–34, 46, 83–84, 86–91, 94–98, 124–125, 127, 138, 142, 146–147, 181, 213, 234 Lyon Summit, 339 M Malaysia, 68, 129, 153–154, 160, 198, 242, 244 managerial capabilities, 80, 123–124, 160 managerial innovation, 179 managerial ties, 79–81, 85–88, 92, 98–100, 146 March, 72, 79, 135, 237, 283, 317, 301–302, 333–335, 339, 342 Market competition, 97 market corruption, 227 market-oriented strategy, 120–121 marketization, 96, 98 marriage, 5, 26–27, 59, 107 Marx, 216 masculinist features, 28 massive competition, 161–163

b3718_Index.indd 376

McDonald’s, 61, 72, 144 McGuinness, 90 mediation, 19, 36 meta-analysis, 91 Meyer, 33 mianzi, 10, 14, 52, 59, 140–141, 148, 224, 289 Michael Miles, 129 Mid-Autumn Festival, 59 mid-end market, 162 Miles, 80, 120–121, 186, 211 Miller, 120 Ministry of Commerce, 166 Ministry of Foreign Trade and Economic Cooperation, 166 Minnan Delta, 69 mobility of guanxi, 57 mode of entry, 188 Monarch Headgear, 49 money laundering, 347 moral degradation, 219 moral panic, 219 moral standards, 98 Morgan Stanley Asia, 101 Motorola, 171, 174–176, 179, 181–183, 187 Multilateral Development Banks (MDBs), 340–342 multi-market competition, 163 N NAFTA, 339 Nash equilibrium, 209 national integration, 172–173 National People’s Congress, 168, 316, 320 Nee, 47, 82, 116

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b3718   Guanxi and Business

Index   377

negotiation, 61, 118, 150, 303–304, 338 Neil Bush, 152 nepotism, 96, 237, 316 network capitalism, 118 networking, 11, 23, 37, 39, 46, 52–53, 55, 63, 71, 76–77, 83, 85, 99, 115, 118, 123, 128, 177, 193, 196, 251, 268, 307 Newbridge Asia, 102–103 new generation, 158, 160, 162–165, 171, 174–179, 181 niche competition, 161, 163 non-cash items, 326 North American Development Bank (NADBank), 339–340 North China Industrial Corporation, 319 nuo yong, 313 Nye, 204 O obligation, 4, 15, 21, 28, 35, 44, 51–52, 59, 71, 85, 146, 252 “obtaining” business, 327 Organisation for Economic Cooperation and Development (OECD), 334–339, 343, 349–350 Oldenburg, 228–230 oligopolistic intensity, 251–253, 258–259 Oliver, 112, 115 one-child policy, 158 open-system models, 113 opportunism, 14, 18, 32, 47, 118, 190, 223–224, 230 organizational competency, 54

b3718_Index.indd 377

organizational factors, vi, 121, 125, 127–128 organizational guanxi, 295, 297–298 organizational image, 83 organizational isomorphism, 80 organizational networks, 112, 115 Organization of the American States (OAS), 335, 338–339 ownership structure, 117, 122, 127, 239 P Pan Asia Technical Automotive Center (PATAC), 301, 303 Paolo Mauro, 225 parent integration, 172 Pareto optimality, 225 Pareto optimum, 225 Park, 80–81, 91, 95, 114, 127, 146 parochial corruption, 227 Pearce, 34, 95, 122 Pearl River Delta, 69 Peng, 46, 82, 88, 91, 98, 100, 117, 134, 146 Pennings, 80 People’s Bank of China, 74, 105, 107 People’s Liberation Army, 103, 212, 278, 284 performance, v–vi, 19, 28–29, 33, 36, 55, 73, 79–82, 84–97, 99–100, 104, 107, 116, 122, 133, 137–140, 142–144, 146–149, 162, 176–177, 180–181, 188–191, 197, 205, 234, 238–239, 241, 271, 273, 275, 299, 320, 327–330, 344–345

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b3718   Guanxi and Business 6"×9"

378   Index

personal relationships, 4, 11, 30–31, 35, 49, 53, 57, 62, 82, 112, 115–116, 145, 150, 290, 292, 299, 316 personal trust, 17, 300 Pete Engardio, 200 Pfeffer, 33, 48, 113 Philip M. Condit, 198 Philips, 181, 185 pianqu, 313–314 ping, 13, 134 Polanyi, 232 political favors, 81 political protection, 116, 121 political uncertainty, 49, 65, 118 Poly Technologies, 103 population ecology theory, 124 Porter, 119–120 Powell, 115 power, 4, 21, 25–27, 30, 32, 37, 40, 44–45, 48–49, 60–61, 63, 66, 84–85, 94, 96, 108, 113, 115, 117, 122–123, 153–154, 160, 163, 165, 166, 170, 173–174, 179, 182–183, 204–211, 214–218, 220, 222, 224, 233–234, 244, 250–251, 253–257, 260–261, 263, 276–277, 279, 283–284, 290, 293–294, 300, 305, 313, 318, 328 Prahalad, 123, 162 Price Law, 167, 169 Price Waterhouse, 74–75 pricing, 86, 89, 99–100, 124, 138, 139, 163, 167, 169, 178, 237, 253 princelings, 41, 105, 107 procedural malfeasance, 259–260, 263, 274 procedural malfeasance, 260 professionalism, 17

b3718_Index.indd 378

profit growth, 86, 88–89, 99, 126 promotion, 11–12, 25, 48, 62, 83, 112, 129, 179, 185, 285, 311, 329–330 prospector, 120 Protestant ethic, 60 public official, 265, 325, 345, 347 Q Qian Qichen, 38 Qingling Motors, 106 qintun, 313–314 R R&D intensity, 138–139 reciprocity, 2, 9–10, 14–15, 28–31, 51, 55, 58–59, 113–115, 141–143, 147–148, 190, 207–209, 224, 298 red envelope, 27, 58, 89, 209 red envelope culture, vii, 203 regression analysis, 88 regulatory control, 252–254, 258, 259 regulatory elasticity, 169–171 regulatory rigidity, 169 relationship attachment, 149 relationship norms, 148 reliability, 16–17, 94, 98, 139–141, 292, 298–299 ren, 13, 30, 105 renqing, 9, 14–15, 27, 35, 52, 59, 85, 141, 147, 208–209, 224 Resolution to Clean Up Corporations, 318 resource-based approach, 114 resource-based view, 123, 235–236 retaining business, 328 Riley, 23 Roche Pharmaceutical, 307

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b3718   Guanxi and Business

Index   379

Rogers, 113 Ronald B. Woodard, 200 Rose-Ackerman, 226, 237 routine government action, 328 S Salancik, 33, 48, 113 sales force marketing, 98, 124, 138–140, 143, 191 sales growth, vi, 79, 83–85, 88–89, 99, 126, 134, 139–142, 186 scant competition, 160 Scott, 231, 291 SEC, 41–42, 270, 294, 330, 336 Securities Exchange Act of 1934, 323 Shan, 121 Shanghai, 26, 41, 56–57, 73–76, 127, 130–131, 151–153, 159, 163, 182, 188, 193, 196, 201, 238, 301, 303–304, 306 Shanghai Analytical Instrument Factory (SAIF), 196 Shanghai Automotive Industry Corp. (SAIC), 108, 130–131, 167–168, 188, 301–305 Shanghai Chlor-Alkali Chemicals, 306 Shanghai Hercules Chemicals, 306 Shanghai Volkswagen, 130–131, 302 Shell, 275 sheng-ren, 9–10 Shenkar, 33, 48 shouhui, 314 shou-ren, 8–9, 224 shu ji, 293 Silver Grant International Industries, 106 Sim Kay Soon, 130

b3718_Index.indd 379

Singapore, 5, 31, 60, 63–71, 103, 107, 129, 160, 189, 198, 218, 242, 244, 306–307, 340 Singapore Airlines Ltd., 198 situation centered, 8 small firms, 121–122 Snow, 80, 103, 120–121 social asset, 126 social bases, 6, 7 social capital, 12, 14, 21, 43–44, 52, 86, 92, 95, 147, 161, 178, 180 social capital theory, 147 social clubs, 6 social connections, 23, 29 social guanxi, 55–56, 397 social legitimacy, 113 social life, vi, 1, 12, 20, 26, 33, 111, 217 social norm, 207 social obligation, 9, 141, 209 social position, 14, 21, 43, 291 social reciprocity, 207–208 social relationships, 4, 23, 28, 35, 44 social resource, 291 social stature, 31 social trust, 48–49 social welfare, vi, 3, 26, 43, 206, 216 societal degradation, 221 socioeconomic, 25, 240 Sony, 182, 187 special economic zones, 67, 69, 119 spoils system, 25 Spring Festival, 58–59 Stamford Raffles, 68 State Administration for Industry and Commerce (SAIC), 108

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b3718   Guanxi and Business 6"×9"

380   Index

State Science and Technology Commission of China (SSTCC), 195 State Asset Supervision Administration Commission (SASAC), 241 statute of limitations, 347 strategic asset, 55 strategic conformity, 81 strategic factor, 119 strategic goals, 53–54, 99, 171, 302 strategic insiders status, 158 strategic orientation, 119–121, 127 strategy–conduct–performance (S–C–P) paradigm, 86 strategy variables, vii, 138 string-pulling, 20 structural malfeasance, 259, 262–263, 273 structural multiplicity, 164 structural similarity, 164 structural uncertainty, 252–254, 258–259 Supreme People’s Prosecutorate (SPP), 213 suohui, 313–314 system malfeasance, 259, 272 systems trust, 17 T Taiwan, 5, 21, 25–26, 66–71, 93, 97, 102, 160, 189, 198, 218, 306–307, 340 Tajfel, 33 tanwu, 313 Taoqu, 313–314 technical competence,

b3718_Index.indd 380

31, 60, 63–64, 152, 154, 277, 280, 302,

89

technical learning, 81 technological capabilities, 160 telecommunications, 65, 76, 151, 194–195 The Economist, 42, 78, 81, 109, 155, 201, 287 the three Cs, 90 Thomas, 40, 80 Thomas Fok, 40 Thorelli, 115 TI, 286, 335–336 Tiananmen Square, 218 Tiaohe, 19 Touji daoba, 313–314 trade association, 6, 15, 255 transferability, 10, 14, 210, 217 Transparency International (TI), 225, 286 Trevino, 80 trust, 13–14, 16–18, 21, 26, 43–44, 46, 49, 57–58, 70–74, 76, 103, 105, 113, 115, 135, 149, 180, 183, 190, 209–210, 223–224, 232, 236, 243, 267, 275, 290, 298, 300, 304, 310, 319 trustworthiness, 18, 30, 236, 299, 307 Tsui, 10, 115 Tung, 17, 39–40, 61, 87, 129–130, 192 Tung firm, 40 U umbrella company, 172 United Nations (UN), 335, 338, 341, 344 United Nations Commission on International Trade Law, 341 United States v. Liebo, 324

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b3718   Guanxi and Business

Index   381

untapped markets, 164, 185 utilitarian, 9–10, 21, 85, 98, 220, 224 utilitarian mechanism, 80 V value chain localization, 175, 177, 183, 185–186 VanRyzin, 138 village enterprises, 12, 82, 161 Volkswagen AG, 130 voluntary relationships, 13 Von Glinow, 33, 48 W Walder, 82 Wank, 49, 51 Warner, 13, 48 Wasserman, 113 Weiss, 122, 138 wei xi, 2 Western networking, vi, 43, 53–54 white, 108, 113, 204 white corruption, 204 wholly foreign-owned subsidiary, 35, 188 wholly-owned subsidiary, 172, 191 Williams, 237, 326 Williamson, 46, 83, 160, 229–231 work place, 289 World Bank, 60, 102, 143, 225, 335, 341–342, 344

b3718_Index.indd 381

World Trade Organization (WTO), 165, 334, 338, 340–341, 344 WTO Government Procurement Agreement (GPA), 340 X xi, 2, 201 Xiao, 134, 282 xiao, 13 Xin, 34, 95, 122 xin, 13 xinren, 16 Y Yang, 4, 8, 22, 27–28, 97, 282, 291 yang, 11 Yanshan Chemical Corporation, 319 Yeung, 17, 61, 87, 89, 129, 192 Yi, 182 yi, 13 yin, 11 yiqi, 35 Yunnan Hongta Group, 276, 279 Yuxi Cigarette, 276–279 Z zhong, 13 Zhu Rongji, 200 zou houmen, 27 zousi, 313, 315 zousi fan, 315

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