China's SOE watchdog pushes for value creation mindset

BEIJING, Jan. 15 (Xinhua) -- China's large state-owned companies with high sales and substantial assets may no longer be deemed "successful" under new government performance measurements.

Huang Shuhe, vice chairman of the State-owned Assets Supervision and Administration Commission (SASAC), has announced the SASAC this year will use the economic value added (EVA) measure to assess the performance of the 129 state-owned enterprises affiliated to the central government.

Developed by the U.S.- based consultancy firm Stern Stewart & Co., the measurement tool has been applied widely among top-tier transnational firms, including Coca-Cola, Temasek, Pemex and others.

EVA refers to the residual income of firms after subtracting costs on all capital employed in the business, debt and equity, from their net operating profit after tax (NOPAT), Erik Stern, Stern Stewart president international, told Xinhua in an exclusive interview.

"It considers not only the actual cost of capital, but also its opportunity cost, in other words the expected returns that could have been achieved with the capital if it had been invested in a similar investment," said Stern.

If a company's NOPAT is 5 million yuan with 100 million yuan capital employed, the profitability is 5 percent. But if the average industry cost of capital ratio is 6 percent, that translates into a negative EVA of 1 million yuan, meaning the firm failed to deliver optimum value for shareholders.

ENDING EMPIRES

Experts hold that a firm' s profitability measures only its profit-making capabilities, while EVA measures its profit-making capabilities compared with its peers, a more scientific and tougher standard.

"Previously, we viewed the large and high-profit-generating firms as good ones. The concept has changed now. Profitable enterprises don't necessarily mean that they have created enough value for shareholders," said Liu Nanchang, head of the Bureau of General Affairs of the SASAC.

Analysts hold that some Chinese firms think that they are "too big to fall" and prefer to "build empires." EVA would make corporate executives more responsible for the capital they are employing, as their investments must beat the cost of capital to deliver positive EVA.

According to the new version of the central SOE performance assessment document to be rolled out soon, EVA will replace return on net assets. It will account for 40 percent of the criteria governing SOE executive performance. The remaining 60 percent will target profits and other industry-tailored metrics.

VALUE MINDSET

The adoption of the EVA measurement is intended to strengthen central SOE value creation capabilities and increase their return on capital, Liu said.

"In the next few years, we plan to gradually raise the weight of EVA in the measurement system to encourage SOE executives to be more value-driven and focus their firms on long-term sustainable growth," Huang said.

Many leading transnational firms like Pemex are using EVA as the core metric to assess their investment and performance, Stern said.

"Corporate executives are more likely to be short-term focused on the annual profits. EVA should encourage them to be more forward-looking, as investment in research and development and brand-building would help them to create positive EVA in future years," said Stern.

The SASAC is scheduled to set the threshold capital cost ratio at 5.5 percent, which means an SOE has to earn at least 5.5 million U.S. dollars operating profit after tax if it employs 100 million U.S. dollars in a project.

"We are endeavoring to encourage SOEs to perform better in their main businesses," Li Rongrong, chairman of the SASAC, said last month.

Since February 2009, some non-property SOEs entered the real estate sector as property prices and sales picked up momentum. This is one reason that land prices in some cities have soared, leading to public complaints.

The new measurement document would help slow or even end this practice, as proceeds from non-core business may be halved in the new measurement system, which metes out rewards or punishments for SOE bosses, Liu said.

Analysts said that if SOE executives cannot deliver positive EVA, this would affect their variable pay.

Average per capita income for central SOE executives stood at 600,000 yuan (87,876 U.S. dollars) annually, a third of which is basic salary and the rest variable pay in line with performance, Li Rongrong said at an academic forum in Beijing on Jan. 9.

Liu said the EVA measurement would shock the management mindset at first and change the thinking of SOE bosses. The SASAC was making efforts to improve the measurement system gradually.

The central SOEs under the supervision of the SASAC include China National Petroleum Corporation, State Grid Corporation of China, China Mobile Communications Corporation and other industry giants.

The SASAC estimated all central SOEs had more than 12 trillion in sales and more than 750 billion yuan profits in total in 2009, both better than 2008 levels.

An estimated 90 percent of central SOEs could beat their annual performance goals in 2009 according to the previous performance metrics, Huang said.

However, analysts say that since the SASAC asked about 100 central SOEs to adopt an EVA performance assessment trial in 2007,nearly half could not deliver a positive EVA, especially those firms with fast asset expansions, including petrochemical, iron and steel sectors, showing potential for improving capital use efficiency.

"EVA can encourage an owner's mindset among corporate executives and help to curb wasteful investment, leading them to do wise investments cautiously both at home and overseas and become global industry leaders," said Stern.