• The Chinese Communist Party has renewed its efforts to establish party organizations in Chinese companies, both state and private.
• There is a lack of transparency about the influence of party organizations within Chinese companies.
• Absent a concerted pushback from foreign and domestic businesses, China is likely to continue pushing for a more expansive role for party organizations in companies.

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.

One of the most contentious issues between China and the United States is the role of the Chinese Communist Party (CCP) in the economy. The CCP has become increasingly strident that it should play the leading role in guiding China’s economy. Xi Jinping has revived Mao Zedong’s mantra that “east, west, south, and north, the party leads everything.”¹ Rather than reducing political intervention in the economy, Xi has declared that CCP leadership is the essential feature of Socialism with Chinese Characteristics, the formulation that describes China’s unique economic system.²

A troubling manifestation of this effort to reassert control over the economy is a renewed push to develop CCP party organizations within companies, both private and state-owned. The notion that a political party, especially one dedicated to communism, should seek to embed itself in companies and exert control from within is antithetical to American notions of capitalism. American companies operating within China and American investors in Chinese companies are faced with the unsettling prospect of a CCP organization inside their company with an unclear agenda and overlapping lines of authority with the company’s managers. There is limited transparency over how party organizations make decisions, what aspects of a company they seek to control, what accountability – if any – they have to a company’s shareholders, and what information they may be sharing with outside parties.

While the CCP’s efforts to control companies is not new, the Xi Jinping administration is undertaking an unprecedented effort to achieve this goal.

A Long-held Goal Unfulfilled

A defining characteristic of modern Chinese policymaking is the CCP’s effort to counterbalance its loss of control over a more open and market-based economy. The CCP has sought to harness the dynamism and wealth creation of the market, while intervening frequently to guide the economy towards policy priorities and preventing private companies from becoming competing sources of power.

In the wake of the Tiananmen Square protests and violence of 1989, the CCP undertook a massive effort to reassert its control over China, including the economy. In 1993, the CCP first laid out the legal requirement for all companies to allow the establishment of party organizations.³ In the early 2000s, the CCP underwent a major ideological shift and formally invited private entrepreneurs into the party. This was a recognition of the rising importance of the private economy and that co-option was the only viable path going forward.

While party membership became common for many private entrepreneurs, the goal of establishing strong party organizations in companies languished. Penetration of private companies by party organizations was low in the early 2000s and those that did exist had limited influence, doing little more than studying new party policies. Figure 1 shows the prevalence of party organizations in private companies during that period (2002) compared to the most recent data available (2018). The prevalence of party organizations in state-owned enterprises (SOEs) was substantially higher. However, high-level CCP officials complained that even in SOEs many party organizations were disorganized and ineffective. During a speech in 2000, President Jiang Zemin decried “lax and powerless” party organizations in SOEs and vowed to address the problem.⁴

Source: All-China Federation of Industry and Commerce.⁵

Tightening the Screws

Since the start of the Xi Jinping Era, there has been a general resurgence of the Party’s efforts to entrench itself in all aspects of Chinese society, including the economy. China’s leaders believe that only by revitalizing and strengthening the Communist Party can China achieve its goal of “national rejuvenation.”

In this context, the CCP has renewed its efforts to establish party organizations in Chinese companies, both state and private. In 2015, Xi Jinping’s signature SOE reform plan, the “Guiding Opinion on Deepening the Reform of State-owned Enterprises,” cited the weak role of party organizations in many SOEs and called for strengthening the CCP’s leadership over these companies.⁶ Subsequent government proclamations have called for the promotion of party organizations within private companies, albeit with less intensity than the policies aimed at SOEs.

China’s Company Law states that companies shall permit party organizations to be established and provided the necessary conditions to operate.⁷ Beyond that, there is no formal legal requirement that party organizations be given operational influence within a company.

As detailed in Figure 2, the CCP Constitution outlines more specific powers for party organizations within companies. It calls for party organizations to be formed in any company that has three or more party members. For SOEs, party organizations should “participate in making decisions on major questions in the enterprises.”⁸ The CCP Constitution sets a lower bar for party organizations within private enterprises, stating that they should “guide and oversee their enterprises’ observance of state laws and regulation.”

In a 2017 revision of the CCP constitution, the role for party organizations in SOEs was further strengthened. For SOEs with a Leading Party members’ group, the party organization shall “play a leadership role” and “discuss and decide on major issues of their enterprise in accordance with regulations.”⁹

Action and Reaction

Since the launch of Xi Jinping’s SOE reform campaign in 2015, China has made a concerted push to formally give party organizations greater influence within SOEs. For listed SOEs, a primary avenue for this effort has been to require SOEs to revise their corporate charters to formally empower party organizations. In 2018, this requirement was formally incorporated into the China Securities Regulatory Commission’s Code of Corporate Governance for Listed Companies.¹⁰

Two studies looking at the adoption of charter revisions by SOEs in the years immediately following the new requirement found differing levels of compliance so far.¹¹ Some SOEs have only adopted symbolic provisions that acknowledge the importance and leadership of the CCP. In other SOEs, the board of directors is expected to consult with the party organizations prior to important strategic decisions. In more extreme implementations, the management of a company may be forced to consult with the party organizations on important operational decisions. Many also require the chairperson of the board to simultaneously serve as the head of the party organizations. Chinese SOEs that were cross-listed on an overseas exchange were less likely than only domestically listed firms to incorporate party committee amendments.¹²

While private companies were not required to incorporate party organizations into their charters, some have undertaken these changes voluntarily. Private firms with party members on their management team or board of directors were more likely to incorporate the charter changes.¹³ However, relative to SOEs, private companies have been reluctant to adopt provisions that grant party organizations operational control and generally favor only symbolic changes.

The push to establish party organizations in companies has generated a strong backlash from foreign companies operating in China. The European Chamber of Commerce has been vocal about its opposition to an expansive role for party organizations within European joint ventures with local SOEs.¹⁴ At present, there are only scattered reports of foreign companies in China facing pressure to establish party organizations or give existing ones more influence.¹⁵ However, it is difficult to gauge the true influence of party organizations because many foreign businesses may be reluctant to complain for fear of damaging their relationship with the Chinese government.

For Chinese companies overall, there is a lack of conclusive evidence about the influence of party organizations. Chinese companies have been eager participants in a range of government policy efforts, ranging from the Belt and Road Initiative to the campaign to develop domestic sources of technology. The motivation for joining these efforts likely stems from a mix of financial incentives, a desire to maintain good relations with the government, and possibly behind-the-scenes pressure from a party organization.

What can be said definitively is the government is not yet satisfied with the influence of party organizations, particularly in private companies. At the end of 2019, the Central Committee of the CCP and the Chinese State Council encouraged private companies to strengthen their efforts in establishing party organizations.¹⁸ In 2020, the Vice Chairman of the All-China Federation of Industry and Commerce called for a renewed push to establish party organizations in private enterprises, describing private entrepreneurs as the “helmsmen of a ship” and party organizations as the “compass” that guides the ship’s direction.¹⁹ Absent a concerted pushback from foreign and domestic businesses, the Xi Jinping government is likely to continue pushing for a more expansive role for party organizations in all Chinese companies.

A Line in the Sand

On the issue of party organizations, U.S. policymakers are justified in taking a hard line and offering limited scope for compromise. The CCP has overreached beyond the legitimate purview of modern market economies by seeking to establish and strengthen party organizations in private and listed companies. Western governments would be correct in classifying China as a non-market economy and establishing countervailing economic restrictions. If party organizations are left unchecked, it could also have disastrous consequences for the Chinese economy, strangling the dynamism and entrepreneurialism out of China’s best companies.

Party organizations may have a role to play within SOEs as a representation of the state’s ownership interest. Regardless, in listed SOEs, the activities, membership, and expenses of party organizations should be fully disclosed to minority investors. SOEs should clarify the areas of corporate activity that are subject to control by the party organization, publicly identify the leadership of the party organization, and provide regular reporting to shareholders on its activities. By choosing to raise outside capital, listed SOEs have forgone their right to unfettered political control. Listed SOEs that cannot comply with these requirements should be converted back into fully government-owned enterprises.

For private Chinese companies and foreign companies operating within China, the CCP must make clear that party organizations have no legal basis to demand influence over a company’s operations or personnel appointments. Formal action taken to influence a company must come via the official organs of the government. Private companies that opt not to empower party organizations should not face retaliation or discrimination from the government. Anything less than this will undermine the notion that China should be treated as a modern and rules-based economy.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

As of March 31, 2021, the Seafarer Funds did not own shares in the entities referenced in this commentary.

1. “At the Closing of the People’s Congress, “Xi Jinping’s Speech Emphasizes the Party Leads Everything (人大闭幕: 习近平演讲强调 “党领导一切”),” BBC News, 20 March 2018.
2. “Xi Jinping: The Leadership of the Communist Party is the Essential Feature of Socialism with Chinese Characteristics (中国共产党领导是中国特色社会主义最本质的特征),” People’s Daily, 16 July 2020.
3. Jude Blanchette, “Against Atrophy: Party Organisations in Private Firms,” Made In China Journal, 18 April 2019.
4. “Jiang Zemin: In Accordance with the Requirements of Three Represents, Earnestly Strengthen Party Building (按照 “三个代表” 要求, 切实加强党的建设),”, China Reform Database, 14 May 2000.
5. “An Analysis Report on the Current State of Party Building in Private Enterprises (我国民营企业党组织建设现状分析报告),” All-China Federation of Industry and Commerce, 23 May 2019.
6. “Guiding Opinion on Deepening the Reform of State-owned Enterprises (关于深化国有企业改革的指导意见),” Central Committee of the Chinese Communist Party and the State Council of the People’s Republic of China, 19 September 2015.
7. “Company Law of the People's Republic of China (2018 Amendment),” China Law Info, 26 October 2018.
8. “Constitution of the Communist Party of China,” Xinhua, 24 October 2017.
9. A leading party organization, or Leading Party members' group, is a more organized and influential version of a grassroots party organization. Rather than electing its own members, the membership of these groups is approved by a higher-level party organization. See “New CPC regulation stresses role of leading Party members' groups,” Xinhua, 30 May 2015.
10. “Code of Corporate Governance for Listed Companies,” China Securities Regulatory Commission, 2018.
11. See Lauren Yu-Hsin Lin and Curtis J. Milhaupt, “Party Building or Noisy Signaling? The Contours of Political Conformity in Chinese Corporate Governance,” Journal of Legal Studies, 22 December 2020; and see John Zhuang Liu and Angela Huyue Zhang, “Ownership and Political Control: Evidence from Charter Amendments,” International Review of Law and Economics, 22 July 2019.
12. John Zhuang Liu and Angela Huyue Zhang, “Ownership and Political Control: Evidence from Charter Amendments,” International Review of Law and Economics, 22 July 2019.
13. Lauren Yu-Hsin Lin and Curtis J. Milhaupt, “Party Building or Noisy Signaling? The Contours of Political Conformity in Chinese Corporate Governance,” Journal of Legal Studies, 22 December 2020.
14. “Chamber Stance on the Governance of Joint Ventures and the Role of Party Organisations,” The European Chamber of Commerce in China, 3 November 2017.
15. Alexandra Stevenson, “China’s Communists Rewrite the Rules for Foreign Businesses,” The New York Times, 13 April 2018.
16. A party committee is typically established once a grass roots party organization increases in members beyond a certain threshold, typically 100 members. See Vivienne Zen, “Xiaomi sets up Internal Communist Party Organisation,” Hong Kong Free Press, 29 June 2015.
17. “Why do Private Companies have to Build a Party Committee? Party Committee leaders are mostly Part Time (民企外企为何都要建党委? 党委领导多为兼职),” Xinhua, 06 July 2015.
18. “Opinions on creating a better development environment to support the reform and development of private enterprises (关于营造更好发展环境支持民营企业改革发展的意见),” Central Committee of the Chinese Communist Party and the State Council of the People’s Republic of China, 22 December 2019.
19. Ye Qing, “Promoting the Organic Integration Between the Party’s Leadership and the Governance of Private Enterprises (推动党的领导制度体系与民企治理体系有机融合),” All-China Federation of Industry and Commerce, 17 September 2020.