Toward a Theory of Internal Governance Structure of China’s large SOEs

This paper constructs a simple model to reveal the trade-off between decentralized and centralized governance structure of large state-owned enterprises (SOEs) in China. Our model shows that the delegation of decision making authority to SOE managers would enhance their initiative in terms of local investment while in meanwhile might lead to the ex-post moral hazard problem. The business empire building effect causes the misalignment between SOE managers’ personal interests and organizational interests as a whole. We introduce a mechanism so called constrained-delegation approach to illustrate the issues that by eliminating some of SOE managers’ empire building investment choices, the trade-off between centralization and decentralization with respect to the loss of control vs local initiative could be resolved. In the end of this paper, we also discuss the policy implications of such constrained-delegation organizational structure with particular reference to the rationale of the party-committee control within large SOEs in China