Raising dividends could derail earnings of SOEs

When China pledged to further raise the dividend ratios of State-owned enterprises (SOEs) during the fourth round of the recent China-US Strategic and Economic Dialogue held in Beijing on May 4, many people applauded the decision.

Following the tax reforms of 1994, China stopped pushing for dividend payouts from SOEs after the majority of these firms posted losses. However, in recent years, many SOEs have seen not only their profits but also salaries for senior executives at these firms skyrocket, which led to calls for a return to hefty compulsory dividend payments. According to the Ministry of Finance, SOEs in China earned 2.26 trillion yuan ($357 billion) in profits and 36.79 trillion yuan in revenues in 2011, up 12 percent and 21.5 percent year-on-year respectively. After the case was made that mounting SOE gains should be shared with the whole country, the government raised the divided payout ratio for these enterprises to an average of 10 percent last year.

It has been put forward that compelling SOEs to hand over more in dividends could curb blind investment in these companies, narrow the widening gap between rich and poor, and shore up funding for China's insufficient public welfare system. Unfortunately, rather than accomplishing these goals, I believe that further hikes to the dividend payment ratios of SOEs will place a heavy burden on the country.

At present, SOE dividend ratios vary by industry and profitability. In general, the more money a State-owned company makes, the more it is required to give back in the form of dividends. If dividend ratios continue to grow, certain SOEs may try to hide their earnings or deliberately keep their profits low. They may put less effort into developing their businesses and pad their operating costs by, for example, increasing staff salaries and benefits or splurging on office facilities. They could, perhaps, eventually lose interest in turning a profit altogether and choose to operate in the red in order to receive government subsidies.

Actually, a similar situation occurred in China more than three decades ago. Before China's reform and opening up policies of 1978, SOEs were saddled with high dividend ratios, which subsequently led to a drop in production as most State-owned companies opted to lean on the government for financial support rather than putting the time and effort into improving their businesses. Once Beijing turned to tax levies rather than dividend payments as a way to take a cut of SOE profits, efficiency and earnings turned around.

I'm not saying that SOEs should be allowed to keep their profits for themselves. However, it would bring more harm than good to raise SOEs' dividend ratios without first implementing detailed regulations making them responsible for their own businesses and or enacting more effective cost management controls.

Published on Global Times | May 16, 2012