New "China Trends" at DLA Pubs

Yesterday, DLA released the latest issue of their China Trends newsletter. Of note are two articles explaining some changes in recent law.

The first article examines eased foreign investment restrictions in telecom services. The gist of the amendment is that the registered capital requirement has been halved for both national telecom services and intra-regional services, from RMB 2 billion to RMB 1 billion, and RMB 200 million to RMB 100 million, respectively. The amendment is available here.

The second article examines Circular 142 issued by the State Administration of Foreign Exchange. The Circular includes new regulations for currency exchange in an effort to better control the inflow of hot money into China. The scope is large, and the authors do a fine job of breaking the regulation down. Of particular interest:

Like many of SAFE’s other regulations, Circular 142 is broadly drafted, making it difficult to predict how local SAFE branches will interpret and enforce certain provisions of Circular 142.

The authors conclude that in the wake of this circular, foreign investors need "to evaluate currency exchange issues carefully. Particular attention should be given to investments by foreign invested holding companies and FIVCEs, as well as domestic realestate investments and M&A transactions. The major changes for FIVCEs include the requirement that they seek SAFE approval before making an investment, and new concerns about repatriating capital if approval is not received. Circular 142 is available at the SAFE website, here.

There's No Business Like (Chinese) Show Business

The stereotype of the young folks who head to Hollywood with big dreams and stars in their eyes is a familiar one. If the movies and TV have taught me anything it is that just about anybody who tells you they're an actor is probably a waiter/ress or a barista waiting for their big break. Today, the Los Angeles times ran a long article on the front page in Column One about the life of Chinese movie extras in Beijing waiting for their big break, Chinese want a piece of 'Action!'

The life of a Chinese extra bears little resemblance to their Hollywood counterparts:

Production companies pay $7 to $12 a day for extras, but less than half of that generally reaches the actors, given the giant sucking sound of middlemen. Many are poorly treated during production of the 400 movies and thousands of television programs made here each year. This is a country, after all, where lax labor laws can make it cheaper to use humans than computer automation.

Complaints of agent rip-offs abound. Some of the victims who stream in from the provinces with stars in their eyes and a few hard-earned dollars in their pocket find themselves locked in houses where they're charged for food, rent, costumes and agent fees until they're broke, says Zhang Gang, co-founder of the Self-Support Center for Small-Time Actors, a group that fights exploitation.

...

Chen Haoran, 21, offers a tour of his living quarters: a pile of rug liners, some old clothes and a plastic Mickey Mouse shopping bag in a pedestrian underpass he shares with 20 men 300 yards from the gate. You get used to the steady stream of people staring at you, he says, but those who cover their noses in disgust as they pass, not so much.

The lights on the roof of the tunnel burn all night, he says, and the underpass floods when it rains. When it gets really bad, he sleeps in a chair in an Internet cafe for $2 a night.

The police sometimes chase them out of the underpass, but most residents drift back. "Our dreams are here," he says.

Despite the difficulties, dreams still come true:

But the highs can make it all worthwhile, some say. "It's such a joy to act," says Ding Liang, 57, who became an extra after being a soldier, farmer, miner and laborer. "Once you do it well, you feel such a sense of achievement. It's better than anything else I've done in my life."

Another source of inspiration is the likes of Wang Baoqiang, a Hebei village boy who haunted these same gates as recently as 2004 before catapulting to fame. In late August, Wang was voted the most popular TV actor in China, arguably making him one of the biggest stars on the planet.

Across town at his studio, Wang, 24, now surrounded by publicists, producers and hangers-on, reflects on his meteoric rise and the dream he embodies for many extras. "I know many see their hope in me," he says. "As an extra, I lived in a shabby room and earned a few dollars a day. Now, I'm supporting my parents. I feel like I'm living the dream."

Of China's Trade Discrepancies and Chinese Tax Havens

A research paper by the US Small Business Administration was recently posted at the US-China Economic and Security Review Commission, China's Global Trade Balance Discrepancy: Hong Kong Entrepot Effects and Round-Tripping Chinese. The SBA's goal for the research was to discover why there was a $319.4 billion discrepancy between the $554.2 billion China trade surplus with 41 major trading partners as reported by those trading partners, and the $234.8 billion surplus with the same trading partners as reported by China.

The authors identify 7 traditional factors that have been used to account for this discrepancy which has been measured since at least 1999. Those 7 factors are:

1. Indirect Trade Through Hong Kong
2. Hong Kong Price Markup
3. Imports/Exports Measurement Discrepancies
4. Exclusion of Servicing Trade
5. Exclusion of Intangible Trade
6. Underestimate of False Invoicing and Transshipment
7. Process & Improvement Trade

Through an extensive study (based on a 2004 study by Geng Xiao of the Brookings Institution), the authors conclude that the major factor, accounting for ~50% of the discrepancy, is actually the round-tripping of currency for tax haven purposes. The de facto tax haven destination for this currency is Hong Kong.

Here's how the authors say it works: "Chinese enterprises undervalue exports or artificially overvalue imports, in order to move Chinese capital across the Mainland border." This capital then returns to the Mainland as foreign investment and receives a lower tax rate. Hong Kong is chosen as the de facto tax haven for the following reasons:

1. A 17.5% corporate income tax rate compared to China's 25%;
2. Hong Kong only taxes Hong Kong source income;
3. "[A]n extremely tax-friendly territorial principle that is flexibly applied to
   rather loose and relaxed residency and income-sourcing criteria" (essentially the same as the prior factor, but, hey, it's their list);
4. No tax on capital gains, dividends, or retained earnings; and
   
5. The ability to carry losses forward indefinitely.

The authors are thus arguing that about 50% of the discrepancy in reporting is due to Chinese enterprises lying about their trade statistics to pay a more favorable tax rate. One of the main culprits? SOEs, according to the report. Considering this is from the SBA by way of the USCC based on research from Brookings, I think the point is supposed to be that wealthy Chinese people are getting wealthier by lying and cheating on their taxes, kind of like Wall Street corporate fat cats, but not Americans.

Of course, if I was going to make an accusation like that, I'd need some sort of basis for attacking their results. I'm not saying that there ain't a bunch of tax evasion going on, but the numbers seem substantially inflated. Fortunately for me, they make a few of assumptions that make their results questionable:

1. Rather than offer actual evidence of round-tripping, they assume that since both the de jure tax haven of the British Virgin Islands and the de facto tax haven of Hong Kong, plus a handful of other tax havens, provide over 50% of FDI into China, that in and of itself is direct evidence of round-tripping. That's a fine assumption if the Chinese were the only ones to actually use tax havens. They're not.
2. The data is based on a "conservative" estimate of a Chinese round-tripping FDI of 50%, and a returned round-tripping FDI ratio of 25%. The 25% comports with Xiao's findings, but the 50% is the high estimate of Xiao's research.
3. This data itself is based on the assumption, from Xiao's research, that the net errors and omissions on the PRC's balance sheet is "a proxy for capital flight," and the assumption "that all capital that flies out of the Mainland is through an overstatement of Chinese imports."

Guestimations are fun, but using a string of guestimations based on guestimations to advance policy seems irresponsible. There is simply no hard evidence that $150 billion of the FDI into China last year was round trip capital for the purpose of tax evasion. It would be hard to figure this number out in any country, but there are too many assumptions working in this study for the final numbers to hold too much water.

Posts of the Week: 10/20 - 10/26

China's Land Reforms Offer Plenty for American Midwest's Agricultural Business at China Briefing

How To Globally (And In China) Protect Your Trademark at China Law Blog

China policy proposal of the day at Marginal Revolution

Recession comes to China at Free exchange

What if pigs fly? at China Business Law Blog

Lies, Damn Lies at China Environmental Law

Paulson Urges Next US Leader to Continue China Talks at WSJ: China Journal

Are We Already in a Cold War with China?

If you ask the State Department's International Security Advisory Board, the answer's a definite yes. A few weeks ago, Condoleeza Rice asked the ISAB to produce a report on how to improve cooperation between the US and China. They handed back a report detailing China's nuclear capabilities and a Chinese policy of creating a "mutual vulnerability relationship" with the US.

This report was first described in the "impartial" Washington Times. I found about the report from the FAS Strategic Security Blog. FAS is typically paranoid, or security conscious, or whatever you want to call it. What is extremely clear is what they call ISAB's report: a bunch of hot air. No, we're not in Cold War 2, we shouldn't get in Cold War 2, and we should cooperate as much as possible to make sure that we have openness to ensure we don't get in Cold War 2.

Not often that you get the FAS playing down nuclear threats. Thank you!

Quick note: Paul Wolfowitz is head of ISAB.

FT on China's Troublesome Transportation Networks

Last week the Financial Times produced a special report on China, Doing Business in China. Most of the articles are about business between China and the UK, including hurdles as well as efforts to shorten the height of those hurdles. One article with a more general applicability to doing business in China, Missing Links, addresses problems with China's transportation networks.

The article argues that China has several regions with impressive logistics and transportation capabilities, including parts of Guangdong province, Shanghai, Tianjin, Qingdao, and Dalian, but that these systems are fragmented and are all designed to get products out of China. It is very difficult to move products internally, and the author says that this fragmentation drives up costs.

The main problem, according to the author, is a rail system that hasn't significantly expanded in 5 years. This has created heavy reliance on trucking which is inefficient due to China having 70% of the world's toll roads, opportunity for demanding bribes on long drives, theft, and a difficulty in tracking goods. Fortunately, plans are in the works for expanding the rail system.

This whole thing sort of reminds me of 19th & early 20th century Mexico where US railroad companies went in and built all of the railways traveling north/south. Great for the export business, bad for domestic business.

How Land Reform Makes Me Feel

I swear this is not [just] the inane ramblings of a Bachelor of the Arts from THE liberal arts college. No no no. Buried somewhere beneath the drivel I'm about to spit forth is a complex narrative on comparative psychological norms regarding the purpose of property laws.

A couple of summers ago, just after my 1L year without a shred of knowledge about the laws of foreign nations, I sat freezing with twelve other US law students in what may have been the most ACed room on Jiao Tong University's Minhang campus while listening to a lecture on China's property laws by a Jiao Tong professor. When the professor started explaining that China does not have real property ownership, but land use rights akin to a lease from the government (30 for agricultural, 40 for recreational, 50 for industrial, and 70 for residential), I thought, "Huh?", but not in those exact words. Then, my arm shot up. "What happens to your ownership rights when the 'lease' runs out? Do you have to repurchase the rights?" He replied that no one can really know what the government will do, but that many are simply proceeding as if the government will grant free and automatic renewal or extension. I think I then grumbled something under my breath about not trusting even my own government with something like that. Why, when they have it, would they just give it right back to you? It isn't yours anymore, it's theirs! And, I tend to think more highly of my own government than anybody else's government.

A year later these leasehold type arrangements made me feel a lot less uncomfortable. At some point after that summer for some reason, I was searching for game preserves for sale in Africa and I found that many only had 99 year leases. Since other countries did the lease thing, it made me more comfortable with China's lease thing and land use ownership in China.

China's new land reforms for agricultural land have eased many of my worries. In the year the earliest land use rights would have expired, they were extended for another 40 years. As long as China keeps becoming more transparent and more comfortable with private property ownership, then I'd heed the advice of my professor and assume, with an air of caution, that any land use rights purchased today will be permanent.

To sum up: the recent land use reform makes me fell really really good. Not necessarily warm and fuzzy, but good.

Substantive Blogging on the Land Use Reforms:
China’s Land Reforms Offer Plenty for American Midwest’s Agricultural Businesses at China Briefing
Land lovers: Rural land-use reform makes sense at CER: Editors' Journal
Reading Tea Leaves On Rural Reform at TIME: China Blog
Land Reform. It's A Coming. Sort Of? at China Law Blog

Posts of the Week: 10/13 - 10/19

Who Won The IPR Dispute At The WTO Between China and the US? at IP Dragon

Choose the Best Sourcing Destination: China's Complex Advantage at China Sourcing Blog

Land Reform. It's A Coming. Sort Of? at China Law Blog

Will the world’s macroeconomic imbalances soon reduce to China’s surplus and offsetting deficits in the US and Europe? at Brad Setser: Follow the Money

How do the People's Republic of China and Hong Kong relate to each other regarding IPRs at IP Dragon
And at IP ThinkTank.

Phony Sony -- or 索爱 at IPKat

Microsoft to Launch Stricter Anti-Piracy Campaign in China at China Briefing

Hubei's Vanadium Smelters (II) at China Environmental Law
In particular, original paragraph 4.

First lawsuit against Sanlu for death due to tainted milk at Chinese Law Prof Blog

Exporters have to come to terms with global slowdown at CER: China Logistics News

Food for Thought:
On Human Rights, Intervention and the International Order at Fool's Mountain

They Even Allow Sexy Pole Dancing Classes in Communist China!

At least that's the way I read the statement made by Witold Walczak, legal director of the American Civil Liberties Foundation of Pennsylvania, in response to his client winning a suit to operate a pole dancing class in Butler County, PA:

“It’s great that Adams Township will join China in allowing a dance studio for Butler County women who want to learn more about pole dancing, the latest worldwide fitness craze.” (h/t WSJ: Law Blog)

Fine rhetorical flourish, and a little trash talking always makes the competition a little more fun. I wonder if Mr. Walczak would be up for a game of Madden?

In re pole dancing in China, you might recall a post from Danwei earlier in the year, Pole dancing: for fitness, not about sex.

When Do CJVs Make Sense?

Nifty article at China Law & Practice on implementing FIEs with preferred stock structure by Greg Pickrell and Judy Deng, Preferred Stock Structure: Theoretical and Practical Issues of Implementation in Chinese Foreign-invested Enterprises (sorry, subscription only access [I don't pay, but my school does]) . The goal of the article is to pick out ways to play with and recommend ways to modify Chinese law to allow preferred stock so that VC and PE firms can retain veto rights despite the percentage of equity they hold in a company, or to allow PE and VC funds founded in China to have multiple stock classes. My biggest takeaway from the article is that the red-headed stepchild of the FIE world, the Cooperative Joint Venture (CJV), is getting some loving.

The reasoning is pretty simple. An Equity Joint Venture (EJV) does not allow for preferred stock because voting rights in the company are determined by equity investment in the company, and China's registered capital system does not allow for a preferred stock investment in an EJV. A Wholly Foreign Owned Enterprise (WFOE) could have preferred stock if it was acquired with private equity and organized under the laws of a different country, which the authors say is allowed, but venture capital investments into a Chinese company wouldn't work with a WFOE because it wouldn't be WFO. This just leaves the CJV.

The CJV is a nice option because at the time of formation the founders can create a legal fiction of multiple classes of stock. In legalese, a legal fiction means pretty close to the opposite of what it means in English. The articles of incorporation can be written in such a way as to give some investors all of the rights that a preferred stock holder wants while giving all the other investors rights that are more similar to a common stock. It might take a bit more work, but that is pretty cool.

Of course, if you want to form a PE or VC firm in China, rather than acquire targets or invest in businesses, then there are different options. If you want a WFOE, then the WFOE can be formed under the laws of a different nation with any sort of structure you want. If you want to form a VC or PE company with a Chinese partner, then a CJV might be clever for the reasons mentioned above to protect certain investors, but the authors point out that EJVs are done. The final option is to choose the little understood and vaguely legislated Foreign Invested Venture Capital Fund (FIEVC). The authors try to figure out what is going on this with this type of FIE, and make recommendations for future implementing regulations. But, the jury seems to be out.

Good article.

For more on why the FIEVC regulations don't make sense, check out the Venture Capital FAQ at Lehman, Lee & Xu.

Is the White on Red Really That Hard to Read?

UPDATE: Deeper red. Bigger font. Better?

This is in response to a comment from a Reddit user:

White text on a red background. Jebus, my eyes are bleeding.

My eyes bleed on the any color text on a white background, sort of like reading a book in the sunlight without shades on.

Should I change it up?

Maybe switch the red and the blue? A darker red? Realize that I'm not the one reading my posts and go with a more traditional black on white?

My only problem with the latter option is that I want to keep some of the stereotypical red in here, and I'm concerned about copping CLB's style.

Thoughts? Don't be bashful, just because I'm attached to my style doesn't mean I'm unwilling to make changes for y'all.

When the Good Times Come to An End: "Bankruptcy in China"

Last year I asked one of my professors about what exactly his UCC: Article 9 class covered. After his quick primer on Article 9, he suggested that a practice combining Article 9 and bankruptcy would be smart because the lawyer would be prepared to handle the legal issues in good times and bad times of secured financing. We (the world[?]) are in a bad time with secured financing. So bad that stores are having trouble getting inventory and/or floor plan secured financing from lending institutions. Without this financing they can't restock with stuff from China. Without orders from abroad (with other possible factors), many Chinese manufacturers are going out of business. A fine article in this week's Economist, Silent busts, runs down some cons and more cons of the three ways Chinese business owners shut down their companies.

Informal Agreements With Employees
Portrayed as the second best option, this apparently consists of negotiating with all concerned parties until a satisfactory payout is decided upon. The example given in the article is from a manufacturer in Shenzhen, and it is unclear whether he actually reached a deal with the more than twelve government agencies that got involved. Apparently everybody wanted a piece of the action, and the price increased each day.

Bankruptcy Reorganization Through the Courts
The Enterprise Bankruptcy Law (and some SPC Provisions) is described as "incomplete and poorly understood." Vagueness in the claim priority of lenders is suggested as the main problem. This makes new lenders unwilling to lend to the firm because they have no idea where they sit in a priority dispute which means that these proceedings rarely have any effect.

Walking Away
The article doesn't go into detail, but I presume that the argument goes that if you lock the gates and flee, and angry workers don't catch up with you it's cheaper and easier to just walk away[?]. As a law student aspiring to be an attorney, this position is impossible to endorse.

I'm not sure I could endorse any of the above. Don't let your business go bankrupt in China. I'd write a winking smiley face as punctuation for that last sentence, but I'm really trying to avoid emoticons in this blog.

The Fourth Way
I said three, right? Well it is China, and it'd probably be a mistake to not look for the fourth way. This fourth way would be the quiet informal recapitalization by the local government of a prestigious local firm that might even be publicly listed. Helena Huang of Kirkland & Ellis is paraphrased as saying it is not uncommon for a local government to bailout a company for fear of workers losing jobs and knocks against the bureaucrats' reputations.

To sum up the Fourth Way: be too big to fail (think AIG), or be buddies with the people in power (refresh my memory, who did Hank Paulson used to work for?).

Posts of the Week: 10/6 - 10/12

Messrs. Reid and MacKinnon's Checklist on Protection of IPR in China at IP Dragon

What China Can Learn From Wall Street's Meltdown: Part III at Managing the Dragon

Court takes freedom-of-information case against Anhui provincial government at Chinese Law Prof Blog

A US-China Comparison of Legal Authorization for Corporate Social Responsibility Pt. 2: The US

The first thing for a businesslike understanding of the matter is to understand its limits, and therefore I think it desirable at once to point out and dispel a confusion between morality and law, which sometimes rises to the height of conscious theory, and more often and indeed constantly is making trouble in detail without reaching the point of consciousness. You can see very plainly that a bad man has as much reason as a good one for wishing to avoid an encounter with the public force, and therefore you can see the practical importance of the distinction between morality and law. -Oliver Wendell Holmes, Jr., The Path of the Law

In "Our Schizophrenic Conception of the Business Corporation," William Allen describes the two conceptions of the corporation. The first conception is that the corporation is the private property of its shareholders. This view is most strongly defended by Milton Friedman in an article he wrote for New York Times Magazine almost 40 years ago, The Social Responsibility of Business is to Increase its Profits. The gist of this conception is that if corporations aggressively pursue profits and a return for their shareholders, then prices will decline while innovation improves resulting in a net benefit for society. Anything else is beyond the scope of what a corporation is supposed to be doing.

The other conception of a corporation is that it is not strictly private because it enjoys many benefits bestowed upon it by the government including "its juridical personality, its characteristic limited liability, and its perpetual liability." These grants by the government "can be seen as including the advancement of the general welfare." This conception believes that the corporation owes a duty to parties beyond the shareholders, it believes that the corporation owes a duty of loyalty "to all those interested in or affected by the corporation."

How has this played out in the US? Let's take a look at some case law, followed by some federal statutes, pending state statutes, and tax statutes.

Case Law
The best place to start is with the case that is in every US corporate law casebook, Dodge v. Ford. Yes, that would be those Dodge brothers, and that Ford.

A little history. The Dodge brothers had invested a bunch of money in FoMoCo while they were building their own automobile business. They were using dividends from their Ford stock to finance a substantial portion of their business. From all appearances, Henry Ford didn't appreciate the competition so he decided to "freeze-out" the Dodge bros. by holding on to profits and refusing to distribute dividends. Henry Ford said that he refused to pay out dividends because of expansion plans, but evidence showed that expansion plans would not consume anywhere near the ~$60 million in capital surplus FoMoCo had. So, the Dodge bros. pointed to Henry Ford's testimony, which made the court very uncomfortable:

"My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes."

The opinion may have been written in 1919, but treating FoMoCo "henceforth as a semi-eleemosynary institution and not as a business institution" was enough for the judges to rule that FoMoCo had to pay out some dividends because corporate social responsibility did not legally extend to greater community engagement, and could not turn the corporation into a charitable institution.

Another case that makes sense to look at is Shlensky v. Wrigley. That would be the man behind this Wrigley, concerning the field that this Major League Baseball team plays in. The plaintiff, Mr. Shlensky, asserted that Mr. Wrigley as president, director and majority shareholder of the Chicago Cubs was acting to the financial detriment of the Cubs and thereby shareholders in the Cubs by refusing to install lights at Wrigley Field. Lights would allow nighttime baseball games which might have larger crowds at the stadium and larger television audiences for increased ad revenue.

Mr. Wrigley offered two reasons for not installing lights: 1) "Baseball is a 'daytime sport,'" and 2) "the installation of lights and night baseball games will have a deteriorating effect upon the surrounding neighborhood." My professor summed this up as Mr. Wrigley is acting upon a responsibility to be good to his neighbors, and he's acting out of an "enlightened self-interest" in exercising his own vision of what baseball is supposed to be. Different States, and thus different laws, but the judges from Michigan in Dodge v. Ford might rule that Mr. Wrigley is acting to the detriment of his shareholders by engaging in community involvement that doesn't bring a return to his shareholders. But this Illinois court actually goes out of its way to make excuses for Mr. Wrigley's behavior.

They say that the lack of lights might actually be good for the Cubs for several reasons: 1) property value is protected or at least maintained; 2) caters to a higher class of patrons; and 3) attendance doesn't appear to effect earnings. The judge might be a Cubs fan searching for excuses for Wrigley, but the nature of these arguments is important. The excuses are based in net economic benefits to the Cubs organization, not net social benefits to the city and citizens of Chicago.

Both of these cases follow the Friedman conception of a corporation, devoid of the advancement of general societal welfare. It appears that under US case law if you want to do good, your goodness better be bringing a return to your shareholders.

Interplay Between Federal and State Statutes
State statutes largely govern the function and duties of corporations. However, with publicly traded companies there are federal statutes which regulate corporate governance and provide a legal frame for the social responsibility that most of the world's largest and most powerful corporations are required to abide by.

Federal Statutes - For Publicly Traded Companies
The US has a big 'ole regulatory body with the purpose of rooting out and punishing those individuals and corporations who break its corporate governance rules: the Securities & Exchange Commission. If you're a public corporation and you don't want to get sued for a bunch of money or possibly go to jail, then it's a good idea to abide by their rulebook: the Securities Exchange Act of 1934 (and the '33 one, too, sort of). This is basically a list of dos and don'ts. The rules that get the most play are rules 10b5 and 14a3 of the '34 Act, and the SEC rules promulgated under Sarbanes-Oxley.

Rule 10b5 prohibits manipulation or deception by directors and executives and other insiders in connection with the purchase or sale of stock by untrue statements of material facts, omissions of material facts, or other fraud or deceit. This also covers insider trading. There are civil and criminal penalties, as well as allowances for private suits.

Rule 14a3 imposes annual reporting requirements on corporations. The idea is that you shouldn't be misleading your shareholders by fraudulent reports.

Sarbanes-Oxley was passed in response to the accounting scandals of 2001. It contains several new reporting requirements. The most important, onerous, and scary provision is 302, which requries the CEO and CFO to certify the company's financial info. Knowingly certifying a false financial report carries heavy criminal penalties.

So, that's what you don't want to do. That stuff would be bad.

But, none of the federal rules are about making corporations good. They are simply about making sure that they report the truth about their position to the public about their health. Simple governance concerns, nothing more. It is just a simple responsibility to shareholders to keep them in the loop about the company they have invested in.

Again, this follows the Friedman conception of the corporation.

State Law
Under our annoying, but endearing, federalist system, each State has its own laws, so we're gonna take a sort of general look at this. Each state's corporation laws govern how a corporation is supposed to act. If the corporation is publicly traded then it must abide by both the SEC requirements, and the laws of the state of incorporation.

Corporations only owe two duties under state common law: a duty of care, and a duty of loyalty. These duties are owed to their shareholders.

The duty of care basically says that directors have to pay attention to their corporation, and they have to become informed about transactions.

The duty of loyalty is the duty of the officers, directors, and controlling shareholders of the corporation to not elevate their own interests above the interests of the corporation's shareholders.

These duties are owed only to shareholders follow Friedman's conception of the corporation. However, there is a new strain of laws working their way through state legislatures that would allow directors to consider more than just the interests of their shareholders. These are popularly called "non-shareholder corporate constituency statutes." The Corporate Securities Law Blog does a fine job explaining such a statute currently being considered in California:

The bill provides that, in considering the best interests of the corporation, directors may consider, without limitation, the long-term and short-term interests of the corporation and its shareholders, as well as the long-term or short-term effects that the corporation's actions may have on:

• the prospects for potential growth, development, productivity and profitability of the corporation;
• the economy of the state and the nation;
• the corporation's employees, suppliers, customers and creditors;
• community and societal considerations; and
• the environment.

What does this mean? Well it's pretty innocuous, and it doesn't impose any new duties on directors, but apparently it would allow directors to consider the effects of their decisions on parties beyond just their shareholders. This specific law does not go so far as to say that directors owe a duty of loyalty "to all those interested in or affected by the corporation," but it does provide room for a corporation to act "as a semi-eleemosynary institution and not as [purely] a business institution."

The main problem with this statute, aside form its vagueness, is it seems that it would cut off a whole line of law suits for violations of the duty of loyalty by allowing directors greater latitude in arguing why their questionable transactions where not self-dealing. Despite the good intentions of these statutes, this example might actually allow a corporation to legally act less responsibly than they are now required by framing its actions as beneficial to the constituencies listed in the statute.

Federal Tax Statutes
The tax code is clear that corporations are authorized to engage in a certain amount of annual eleemosynary acts. The exact amount is no more than 10% of a corporation's annual taxable income, which can then be deducted from annual income (26 USC 170(b)(2)(A)). Anything beyond this could be construed as a violation of duty of care or loyalty to the shareholders by donating more than is rewarded. But, since the corporation is rewarded with lower tax liabilities for donations, it actually makes sense for even a selfish corporation to donate to charity at times.

Conclusion
Under US law, there is certainly a distinction between morality and the law. As long as a corporation is operated for the benefit of its shareholders without violating any of the duties while submitting to required disclosures, it is under no obligation to save the world. Statutes proposed to turn the corporation into a moral institution might actually have the opposite effect in the hands of savvy directors and litigators. There are some rewards for donating to charitable causes, but these are minimal. The Friedman conception of the corporation is strong in America, and we have no requirement that one must be a good man.

What's it like in China? Article 5 freaks me out, but we'll look at it more tomorrow.

Other Posts:
>Part 1

Pollution in China: Coal Quality as Major Culprit

The MIT Industrial Performance Center just released an interesting report seeking to answer why China's new and more technologically advanced coal power plants are spewing out so much pollution, Greener Plants, Grayer Skies? A report from the front lines of China's energy sector (news release h/t to Marginal Revolution).

A widely reported problem with China's energy industry is that smokestack scrubbers and other clean coal technology is turned off to achieve higher efficiency levels and profit margins. The authors of the report say that this is a problem, but

The findings suggest that emissions levels from Chinese powerplants, he said, "depend almost entirely on the quality of the coal they use. When they're hit by price spikes, they buy low-grade coal." Lower-grade coal, which produces high levels of sulfur emissions, can be obtained locally, whereas the highest-grade anthracite comes mostly from China's northwest and must travel long distances to the plants, adding greatly to its cost.

The good news is that the authors find that there is significant "regulatory traction in the [Chinese] system" to encourage and enforce the use of cleaner burning coal. This is probably a good thing for one reason: China's energy security. China is rich in coal and poor in every other traditional fuel source. China demands, and will demand for a long time, steady growth in energy capacity. Coal plants are China's best way of expanding energy capacity while using resources within its borders and keeping energy costs down. They just need to keep it clean.

For the sake of me being able to enjoy rapturous vistas of San Diego's coastline from the golden hill upon which the gorgeous campus of USD sits, I hope China's energy growth is as clean as can be. Especially since I would only be indirectly affected by energy price hikes due to greater coal transportation costs.

Posts of the Week: 9/29 - 10/05

When There Is Blood on The Street... Buy In at All Roads Lead to China

How To Handle Bad Product From Your China Supplier at China Law Blog
Commenting on a post from last week by SRI.

First lawsuit against Sanlu for tainted milk at Chinese Law Prof

The Ten Warning Signs Of A Bad China Deal at China Law Blog
Commentary on a post from Chinese Negotiation Blog.

Paying Your Chinese Supplier - Know Your Payment Terms and Options in Advance at SourceJuice