Performance Assessment of Chinese Central SOEs

1. By Mr. LIU Yuan Bureau of General Affairs, SASAC NOV 19, 2016 Performance Assessment of Chinese Central SOEs

2. Outline 1.General Framework of Performance Assessment 2. Key Points of Performance Assessment 3.Effect of Performance Assessment

3. 1.General Framework of Performance Assessment

4. Brief Introduction According to the requirement of management by objectives, SASAC adopted performance assessment method as follows: 1. Annual assessment ＆ tenure assessment 2.Result assessment ＆ process evaluation 3. Performance outcomes ＆ incentives Bonus and penalty based on performance outcomes. Yearly merit pay based on annual assessment result, and appointment ＆ removal as well as long and medium-term incentives based on tenure assessment result.

5. Basic Procedure 1. SOEs hand in suggestive targets for annual and tenure performance report. SASAC reviews the suggestive targets.Documents for annual or tenureoperational targets are signed by SASAC chairman and major executives of SOEs. 2. SASAC makes dynamic monitoring to the implementation of the documents, while SOEs should hand in regular report on the implementation of the documents. 3. SOEs hand in analysis report of their performance. SASAC reviews the report (including the financial reports), makes the evaluation results classified to 4 levels(A, B, C, D) , and presents feedbacks to enterprises.

6. Performance Evaluation and Remuneration • Annual Performance salary=basic salary×coefficient of annual evaluation results×coefficient of adjustment • Coefficient of annual evaluation results≤2 • D-level: 0-1 • C-level: 1-1.3 • B-level: 1.3-1.7 • A-level: 1.7-2 • Coefficient of adjustment ≤1.5, based on firm's function, asset, revenue, profit, number of staff,etc.

7. Performance Evaluation and Remuneration Tenure incentives: Grant maximum 30% of the total annual pay as bonus according to the tenure assessment results. For enterprises with D-level in tenure assessment, SASAC will make adjustents to their executives.

8. Target Value • How to set the target ? • 1. Vertical comparison: for annual assessment, no less than the average value of the last 3 years or the actual value of last year; for tenural assessment, based on the actual value of the last tenure or the average figure of the target value and the actual value of the last tenure. • 2. Horizontal comparison: benchmarking within the same industry.

9. Annual Assessment • Total score = total profit score+ EVA score+ classification indicator A score+ classification indicator B score

10. Tenure Assessment • Total score=preservation & increment ratio of state-owned assets value score+ turnover rate of total assets score+ classification indicator A score+ classification indicator B score +annual performance score.

11. 2.Key Points of PerformanceAssessment

12. Indicators • According to the principle of “simple but targeted” and “universal and individual”, indicators for evaluation are divided into 2 categories. • 1. Two basic indicators for all enterprises. 1) For annual assessment: profit and economic value-added(EVA) 2) For tenure assessment: ratio of value preservation & increment of state-owned assets and turnover rate of total assets • 2. Two classification indicators for various enterpries, which varies by characteristics of different industry or management shorthand.

13. Indicators • EVA = net operating profit after tax (NOPAT) – cost of capital • = NOPAT–capital after adjustment × the average rate of capital cost • Capital Cost: cost of shareholder’s equity, cost of liability

14. Advantage of EVA Problems with SOEs during their rapid development:excessivegrowth of capital coefficient, declining ROI (return on investment) and increasing operational risk, due to the impulsive scale expansion and aggressive investment increment. Three core concepts are used to restrain SOEs’ investment behavior: 1. Capital has its own cost, especially for equity capital . Executives must adopt full cost accounting in management in consideration of both liability cost and equity cost. 2. Capital has “discipline”. Executives must be responsible for shareholders, and cannot step into the field uncontrolled. 3.Profit is top priority for enterprises, however it is not the only pursuing. Comparing with traditional financial indicators, EVA serves as a more comprehensive value indicators which is more advantageous in performance assessment and long-term value orientation.

15. New Modifications 1. Classified assessment based on different functions of state economy: there will be some differences in both indicators and weight between SOEs which are in fully competitive industry and those in industries and sectors that are vital to national security and national economy. 2.Improving target management: categorize theassessment targets into different levels whichcorrespond to different results; self-imposed stress is encouraged.

16. 3.Effect of Performance Assessment

17. Economic benefits is obviously improved Year 2003 2015 Average annual growth rate(%) Revenue (trillion US $) 0.67 3.39 15.88 Profit (billion US $) 447.76 1872.09 13.89 Total assets(trillion US $) 1.24 7.01 17.06

18. Fine management is encouraged By weighing EVA as a core assessment indicator, it drives the executives of SOEs to control investment and debt as well as make good profits. This could optimize enterprises' investment plan and cut down those unprofitable and long-term investment. Now SOEs attach great importance to analyzing value chain, cutting operational cost and increasing investment efficiency instead of being impulsive in scale expansion previously. SOEs improve the efficiency of capital and the ability to create value through adjusting investment strategy, minimizing capital coefficient and strengthening management towards cost, accounts receivable and inventory.

19. Thank You!