Management and Organization Review 6:1 101-121

doi: 10.1111 / j . 1740-8784.2009.00157.x

Is Entrepreneur-Politician Alliance Sustainable

During Transition? The Case of Management
Buyouts in China

Pei Sun,' Mike Wright,2 and Kamel Mellahi3

l
Fudan University, China, 2Nottingham University, UK, and~'University of Sheffield, UK

ABSTRACT This article explores the dynamic interactions between entrepreneurs and
politicians in transitional China through the lens of management buyouts. Specifically,
we identify two contrasting outcomes of entrepreneur-politician alliances: privatization
buyouts by entrepreneurs implying sustainable original alliances and failed management
buyouts implying the collapse of the original alliances. Drawing on the rent
appropriation literature, we treat Chinese management buyouts as bargaining,
clarification, and redistribution of organizational rent between entrepreneurs and the
government agencies represented by local politicians. We further develop a model of
entrepreneur-politician bargaining that identifies the determinants of varying rent
bargaining and management buyout outcomes.

KEYWORDS China, entrepreneurs, management buyout (MBO), rent appropriation,

transition

INTRODUCTION

T h e rise of entrepreneurship in emerging economies has attracted considerable

scholarly attention (McMillan & Woodruff, 2002; Peng, 2 0 0 1 ; Wright, Hoskisson,
Busenitz, & Dial, 2000). While the characteristics, strategies, a n d economic
impacts of entrepreneurs in C h i n a have m a d e significant progress ( C h a n g &
MacMillan, 1991; T a n , 1996; Tsui, Bian, & C h e n g , 2006; Wright, Liu, Buck, &
Filatotchev, 2008), our understanding of the dynamic processes by which they
interact with other major players during transition, such as politicians, state-owned
enterprises (SOEs) a n d financial institutions, remains i n a d e q u a t e , a n d there is a
need for further contextualization in terms of p h e n o m e n a a n d theory (Tsui, 2006).
T h i s article aims to n a r r o w the gap by analysing the d y n a m i c interactions
between entrepreneurs a n d politicians t h r o u g h the lens of m a n a g e m e n t buyouts in
transitional C h i n a . A m a n a g e m e n t b u y o u t typically involves the acquisition of all
or p a r t of a firm by a new c o m p a n y in which the existing m a n a g e m e n t takes a

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 102 P. Sun et al.

substantial proportion of the equity (Wright, 2007a). In this article, we treat

Chinese management buyouts starting in the late 1990s as involving the bargain-
ing, clarification, and redistribution of firm surplus between entrepreneurs and the
government agencies that politicians represent. The outcome of the bargaining,
i.e., the successful or failed attempt to complete a management buyout, has pro-
found impacts on the durability of the entrepreneur—politician alliance and the
long-term performance of these firms.
In view of various successful and failed management buyouts that have attracted
a great deal of academic, business, and media interests in China, we develop a fresh
analytical framework and theoretical propositions to characterize entrepreneur-
politician bargaining in this emerging market context. In particular, we draw on
the rent bargaining/appropriation literature (Alvarez & Barney, 2004; Bowman &
Ambrosini, 2000; Coff, 1999) to shed light on the complex management buyout
process in China. Moreover, the theoretical model developed in this paper has
potential applicability to understanding the evolution of other types of stakeholder
partnerships. Beyond a focus on politicians and entrepreneurs in transition econo-
mies, the model may be adapted to analyse the dynamics of other stakeholder
relationships by identifying key contextual factors determining the stakeholder
bargaining powers, the intensity of bargaining over new types of organizational/
partnership rent, and the eventual stability of the partnership.
The next section provides a brief overview of the origin and strategic choice of
entrepreneurs in transitional China, with special reference to their interactions
with central and local political forces. Two broad patterns of entrepreneur-
politician bargaining outcomes are identified: (i) successful privatization buyouts by
entrepreneurs: entrepreneurs manage to gain corporate control while politicians
exit, but the alliance remains at work in some different forms from government
control; (ii) the collapse of the original alliance: entrepreneurs fail to gain control
and are dismissed by politicians, who sometimes introduce replacements from
outside. Following the description of two illustrative management buyout cases in
China, we develop a theory of politician-entrepreneur bargaining along with a set
of testable propositions with reference to the determinants of their evolving bar-
gaining powers, the intensity of the rent struggle, and the durability of their
alliances. The final section identifies theoretical contributions, limitations and
future research directions, and policy implications.

CONTEXTUAL BACKGROUND

Entrepreneur-Politician Alliance in Transitional China

Transition in China is characterized by gradual experimentation involving the

emergence of a range of public-private hybrids established by nascent entrepre-
neurs and pro-business politicians (Nee, 1992; Oi & Walder, 1999). These include

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 Entrepreneur-Politician Alliances and Management Buyouts in China 103

township and village enterprises, urban collectives, and reformed local state-owned
enterprises.
Under joint control oflocal politicians and entrepreneurs, key decision-making
in township and village enterprises was subject to bargaining between the two
parties (Oi & Walder, 1999; Zhang, 2008). In some cases, local governments
contributed financial capital at the start-up and were deeply involved in major
decision-making, while entrepreneurs were hired for operational decisions and
awarded more incentive contracts over time (Chen & Rozelle, 1999; Walder,
1995). Many others were established by entrepreneurs who cooperated with local
officials to mask their private nature by designating them as rural collectives where
local officials are generally more removed from firm operations (Chen, 2007).
In the urban sector, entrepreneur—politician partnerships are present in various
government controlled organizations. Some small- and medium-sized local state
owned enterprises and urban collectives developed under the leadership of char-
ismatic managers with an entrepreneurial mindset. Famous examples include
TCL [ I ] and Haier. pi Such entrepreneurial alliances proliferated across the public
sector during the reform era.
This emergence of entrepreneur-politician ventures implies a blurred line
between the identity of entrepreneurs and state sector cadres within these organi-
zations. During transition, some government officials, technocrats, and managers
in state firms became entrepreneurs by demonstrating innovativeness, proactive-
ness, and risk-taking attitudes (Tan, 1996). The emergent group of entrepreneurs
is distinct from normal politicians, though many remained as cadres in the parent
state agencies.
Politicians were also keen to stimulate business ventures for their own ends (Li &
Zhou, 2005; Liu, Sun, & Woo, 2006). First, these hybrid fringe players made a
significant contribution in the context of a cadre evaluation system that exerts
heavy pressures on local politicians to improve the economic growth record of their
jurisdiction. Second, new ventures under their jurisdiction provided politicians,
who had become self-interested, opportunistic agents with a readier means to
derive private gains than through loss-making state owned enterprises.
Since the state still controls a wide range of financial and regulatory resources,
such as access to bank loans, it was natural in the early stage of transition for
entrepreneurs to overcome these disadvantages by adopting a 'boundary blurring'
strategy with political agencies (Peng, 2000). Moreover, strategic political affiliation
helped defuse ideological hostility, policy discrimination, and predation from the
government (Tsang, 1996; Xin & Pearce, 1996). Consequently, political capital
and/or resources, when combined with market-based competences contributed by
entrepreneurs, formed a unique synergy that made such alliances outperform
many state-owned enterprises and private firms.
Although these hybrid forms often outperformed state-owned enterprises, they
have long been predicted to be transitional (Li, 2005; Nee, 1992). Their benefits

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 104 P. Sun et al.

diminish as the growth of market-based institutions and rule-based exchange

reduces the necessity of political affiliation. Despite having vested interests in the
continued success of firms they control, politicians have a strong tendency to use
profitable firms as social instruments for their own ends (Nee, 1992).

Evolutionary Paths of Entrepreneur-Politician Alliances:

T w o Illustrative C a s e s

The subsequent evolution of ownership and control in China largely confirms this
theoretical prediction of hybrids' transitional nature, as a majority of collective
hybrids had been privatized by the early 2000s (Liu et al., 2006, tables 2 and 3;
Kung & Lin, 2007, figure 1). Insider privatization is found to be a major avenue of
ownership transformation in small and medium state firms and collective hybrids
(Garnaut, Song, Tenev, & Yao, 2005).
Not all firms (or entrepreneurs) are that lucky, though. While databases offering
detailed management buyout information are not yet available in China, the data
that we hand-collected from Chinese publicly listed companies suggest that, among
a total of 53 management buyouts attempted by the management from 1996 to
2005, 17 (32 percent) of them failed. Anecdotes abound in the Chinese business
media about high-profile failures of management buyouts in what were once
successful entrepreneur-politician alliances.
It is puzzling that the founding entrepreneurs failed to secure any sizable own-
ership stakes, and some were even removed by the government from their mana-
gerial positions through forced retirement or charges of economic crimes. The
firms in question either remained state-owned or were sold to outside groups.
The possibility of organizational upheaval during a management buyout was
vividly described by a Chinese commentator when discussing the case of'Red Hat'
firms:

It is said that those who wear a Red Hat have a time bomb on their head. The
first type of firms have safely removed the bomb, the second type has not
removed the bomb yet, while the third type blew up when removing the bomb
(as quoted in Chen, 2007: 74).

To further illustrate the stylized patterns noted above, we sketch two cases regard-
ing successful and failed management buyouts. The first case - Midea — was a
township and village enterprise that has successfully transformed itself into a
private business group. [3] It started as a collective workshop founded by Xiangjian
He - then a cadre in the local community - and 22 local residents in 1968. Under
He's leadership, these 23 people contributed a sum of RMB 5,000 and formed the
'plastics production team' in Beijiao Township, Shunde County, in Guangdong.
During the 1970s, the firm was involved in metal processing and the production of

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 Entrepreneur—Politician Alliances and Management Buyouts in China 105

truck components. A notable episode during this stage is that the firm began losing
money immediately after He was promoted to a higher position in the Beijiao
township government in 1977. Thus, the township government decided to send
him back to turn the business around at the end of 1979, and since then He has
never left the firm.
In the 1980s, the firm started to produce electric fans and air conditioners, which
later became its core business segment. Although the township government did not
make any financial contribution to the firm at its founding stage, its support proved
critical during Midea's takeoff, ranging from political legitimacy to access to bank
loans and tax breaks and to the award of export licenses. In 1993, Midea became
the first township and village enterprise listed on the domestic stock market, and
the township government acted as dominant shareholder, owning 44.26 percent
of the equity.
Such clarification of the once ambiguous property rights was not the end of the
story. Behind-the-scenes negotiations between government officials and company
senior managers started as late as 1998 about prospective management buyout
plans. Specifically, He and his associates registered two companies in 1998 and
1999. The official owners of the first company are all managers and employees,
and the other is owned by eight senior managers, including He and his son. The
two companies, in turn, purchased the shares held by the township government at
a price below the prevailing net asset per share. ra Moreover, the two companies
(the management) paid only 10 percent of the total value when concluding the deal
in 2000, while the remaining 90 percent was paid by installment and financed by
bank loans. Interestingly, the loans were guaranteed by the seller - the township
government. The firm continued to grow and prosper after the buyout and is one
of the largest home appliance makers in China.
However, it is not hard to find failed management buyout cases. Located in the
same Shunde County, a once famous township and village enterprise — Kelon — has
a drastically different fate from Midea.L51 Kelon was founded in 1984 through
collaboration between entrepreneurs and the Rongqi township government. At
that time, Guoduan Wang ran a small factory producing cheap transistor radios.
Both Wang and the township government were keen to explore new business
opportunities and investigated nationwide which consumer goods were in high
demand. Ning Pan, a vice-head of the township government, was henceforth
assigned as general manager to work with Wang. Despite the lack of experience
and technical capability in refrigerator production, Rongqi Township provided
seed capital of RMB 90,000 (roughly $30,000 at the prevailing official exchange
rate) and helped to secure a bank loan of RMB 400,000 ($130,000).[6] Kelon
received further essential support from the local government through the intensive
lobbying for a production license from the central government in the mid 1980s.
Kelon's subsequent takeoff was dramatic. By 1991, Kelon had already become
the top refrigerator maker in China, enjoying a 10.3 percent market share.

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 106 P. Sun et al.

Furthermore, Kelon was a pioneer in corporatization experiments. As early as

1992, the firm was transformed into a shareholding company, in which the Rongqi
township government held 80 percent of shares and managers and employees were
offered the remaining 20 percent stakes. In 1996, Kelon became the first Chinese
township and village enterprise that the central government allowed to float on the
Hong Kong Stock Exchange.
Despite Kelon's strong market position during the 1990s, in 2000 it became
loss-making for the first time, with a net loss of RMB 830 million (SI03.75 million)
and with a 30.9 percent sales decline. A further financial hemorrhage of more than
RMB 1.4 billion ($175 million) net losses followed in 2001, leaving Kelon on the
verge of bankruptcy. We suggest that this dramatic change of fortune was related
to a failure in incentive alignment of management and to government expropria-
tion of firm assets.
First, the township government persistendy refrained from granting more own-
ership stakes to company managers so that even the two corporate founders - Pan
and Wang — held negligible shares in the listed firm. Absent formal incentive
contracts, management chose to capture private benefits through self-dealing
activities, pardy evidenced by the soaring operating expenses in the second half of
the 1990s. Another dimension of the failure is related to a series of turbulent
managerial turnovers triggered by the forced retirement of Pan and Wang in 1999
and 2000, respectively. Pan disagreed with the government on the lack of owner-
ship incentive plans for managers and repeatedly prevented the government from
extracting firm resources at its own will. For example, during his tenure, he
repeatedly refused to take over other unrelated loss-making firms owned by the
local government, hence, the purge by the township government. Second, the
township government engaged in intensive asset stripping in the late 1990s. Spe-
cifically, it diverted a total of RMB 1.26 billion ($150 million) from the listed Kelon
Electrical Holdings Co. Ltd through a string of secretive party-related transactions
from 1998 to 2001. In the end, Kelon was hastily sold by the township government
to a private firm in late 2001.
Given the divergent paths of evolution, existing literature has yet to explore how
entrepreneurs managed or failed to decouple the firms from the supervisory/
sponsoring government agencies. What internal and external factors determine the
varying bargaining outcomes? Answers to this question are critical to understand-
ing the dynamics of entrepreneur-politician interactions.

MODEL AND PROPOSITIONS: TOWARDS A THEORY OF RENT

APPROPRIATION DURING INSTITUTIONAL TRANSITION

The foregoing observation of contrasting evolutionary paths in entrepreneur-

politician alliances motivates us to develop a theory of entrepreneur—politician
bargaining in the context of institutional transition. We propose a two-stage

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 Entrepreneur-Politician Alliances and Management Buyouts in China 107

Figure 1. A dynamic model of rent generation and rent appropriation in entrepreneur-politician

alliances

Cognitive Clash between

Entrepreneurs and Politicians

Prospect of

C Contribution to Previous ^ N
„__R.ent G e n e r a t i o r i _ ^ ^ ^
Further Firm
Growth

© ©
Balance of Bargaining Power between
Entrepreneur and Politician ©
0
Distribution of the © Intensity of Subsequent Rent Bargaining
between Entrepreneur and Politician
Appropriated Rents

i©
Subsequent Rent
0
Generation O Total Rent
Appropriation

Stability of
Entrepreneur-Politician
Alliance (Outcomes of M B O )

Notes:
Encircled numbers indicate the related proposition. MBO, management buyout.

dynamic model of organizational rents appropriation in Figure 1, identifying the

key factors determining the durability of the entrepreneur-politician alliance.
We posit that the long-term stability of an entrepreneur-politician alliance
depends on a dynamic balance between the rents created by the two parties in the
rent generation stages and those taken away in the rent appropriation stages
(Proposition 1). Rents generated and appropriated are, in turn, determined by two
important intervening variables - the distribution of the appropriated rents and the
intensity of subsequent rent bargaining, respectively. Differing rent distributions
affect the willingness of the stakeholders to invest in future rent generation and,
hence, the total amounts of rents that will be created by the alliance (Proposition 2).
Further, differing rent distributions lead to varying intensities of ensuing rent
bargaining, which, in turn, impact the total rents appropriated (Proposition 3).
A given distribution of the appropriated rents is the result of a power balance
between entrepreneurs and politicians, which is determined by a wide range of
firm-specific and systemic factors (Propositions 4—9). In addition to impacts from
rent distribution, the intensity of rent struggle is also affected by the extent of
cognitive clash between the two parties over preceding contributions to rent gen-
eration and break-up costs (Proposition 10) as well as the prospect for further
growth (Proposition 11). Overall, these factors interact during the course of tran-
sition to determine the fate of entrepreneur-politician alliances, that is, whether

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 108 P. Sun et al.

they continue to work through a successful management buyout or are dissolved

through a failed buyout. In what follows, we develop these propositions in detail.

The D y n a m i c s of Organizational Rents

Organizational rents are above-normal economic returns stemming from a unique

bundle of resources and capabilities embedded in an organization (Amit & Schoe-
maker, 1993). The rent-generating strategic resources, in turn, must be valuable,
scarce, imperfecdy imitable, and difficult to substitute (Barney, 1986, 1991) to
bestow sustained competitive advantage. Recent studies, however, have noted that
the traditional resource-based view (RBV) of the firm is largely silent on how rents
generated within a firm or across interfirm networks are appropriated by its
stakeholder groups before being observed through conventional performance mea-
sures (Alvarez & Barney, 2004; Barney, Wright, & Ketchen, 2001; Coff, 1999).
Therefore, sustainability of organizational rents also depends on whether the
organization can retain a significant portion of these rents while preventing them
from being dissipated among its stakeholder groups (Kay, 1993).
The formation of organizational rents involves two stages. In the rent generation
stage, rents arise from a nexus of explicit and implicit contracts within the firm or
across organizational boundaries, both of which involve a wide range of stakehold-
ers (Dyer & Singh, 1998; Hill & Jones, 1992). According to the RBV, it is in the
nexus of stakeholder contracting that the potential organizational rents are gener-
ated (hence, the term 'nexus rent' coined by Coff, 1999). In the context of
entrepreneur-politician partnerships in transitional China, the rents of this par-
ticular organizational form stem largely from the unique alliance between human
and political capital under this distinctive institutional environment. Thus, 'alliance
rent' is a parsimonious term characterizing the rent-generating nexus between the
two stakeholders.
Once nexus rents have been generated, they are up for grabs by stakeholder
groups in the rent appropriation stage. In reality, it is quite common that a
significant proportion of nexus rents fail to be retained within the firm but flow to
certain stakeholder groups. The managerial agency problem identified in the
financial economics literature (Jensen & Meckling, 1976) can be reinterpreted as
the grabbing of rents by top executives. Similarly, the scope for rent capture by
managers and financiers in management buyouts has been recognized as a con-
troversial issue in the West (Bruner & Paine, 1988). In the Chinese context,
different outcomes regarding privatization buyouts represent different results of
rent appropriation by management and the government agencies that politicians
represent. Successful buyouts imply a transfer of rents from government agencies
to managers/entrepreneurs, whereas failed ones indicate the opposite.
A key implication of treating organizational rents as the difference between
nexus rents and appropriated rents is that rent appropriation by stakeholder groups

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 Entrepreneur-Politician Alliances and Management Buyouts in China 109

plays an important role in the sustainability of a firm's competitive advantage.

Here, we extend CofPs thesis of stakeholder bargaining by explicidy considering
rent appropriation and rent generation in a dynamic set-up. Specifically, the
functioning of a business firm as a nexus of stakeholder contracts can be seen as a
continuous sequence of rent appropriation and rent generation activities.
As the preceding cases illustrate, an initial unjustified distribution of appropri-
ated rents by key stakeholder groups, such as managers or politicians, may signifi-
cantly impair the incentives of the disadvantaged/dissatisfied group(s) to contribute
to the rent generation stage in the next round, thus resulting in a gradual erosion
of the nexus rents. Meanwhile, an initial unjustified distribution of appropriated
rents may also encourage dissatisfied stakeholder group(s) to devote more time,
energy, and resources to enhancing their bargaining powers in the hope of chang-
ing the current rent distribution in the later rounds of rent appropriation (Baumol,
1990; Skaperdas, 1992). This, in turn, gives rise to more intense bargaining and
more rents being appropriated away from the firm. If key stakeholders can reach
an agreement after the renegotiation about rent distribution, organizational
infighting may come to a halt, with the bulk of organizational rents preserved.
Under some circumstances, however, a downward spiral might occur, resulting in
a steady decline of organizational rents or even a break-up of the original rent-
generating alliance. Thus, we are less optimistic than Coff(1999) about the long-
term stability of a rent-generating nexus. In fact, the stability of the original
stakeholder alliance is positively correlated with the amount of nexus rents generated
in subsequent stages and negatively correlated with the amount of rents appropri-
ated by the stakeholders in subsequent stages. In line with the organizational
evolution of the hybrid firms in transitional China, we offer the following three
baseline propositions, linking stakeholder power balance and rent generation on the
one hand and linking bargaining intensity and rent appropriation on the other:

Proposition 1: The stability of the entrepreneur-politician alliance will be positively correlated

with the amount of subsequent alliance rent generation and will be negatively correlated with the
amount of total rent appropriation away from the firm.

Proposition 2: The more unbalanced the stakeholder bargaining powers and the more uneven the
current distribution of the appropriated rents, the smaller the amount of subsequent rent
generation within the firm will be.

Proposition 3: The more uneven the current distribution of the appropriated rent and the more
intense the bargaining in the subsequent rent appropriation stages, the larger the amount of total
rent appropriation away from the firm will be.

The Determinants of Stakeholder Bargaining P o w e r

To the extent that power differentials between stakeholder groups are the norm in
modern business organizations (Hill & Jones, 1992), one cannot understand the

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 110 P. Sun et al.

distribution of the appropriated rents without examining the determinants of

stakeholder bargaining powers. Coff (1999) outlined four generic determinants of
bargaining powers possessed by management, employees, and shareholders in a
corporate context - capability of unified action, access to or control over informa-
tion, replacement costs if a stakeholder exits, and stakeholder exit costs. While
these general factors go a long way towards helping understand the determinants
of power, without combining details of a particular business context, it remains
difficult to predict an exact pattern of rent distribution among the three groups.
Below, we examine factors that may affect the evolving bargaining powers of
entrepreneurs and politicians in their alliances in transitional China.

Information asymmetry. First, a large part of managerial bargaining power stems from
the information asymmetry between politicians and managers as the latter have
much more detailed information about the internal operation and the true value of
the firm (Roland, 2000; Shirley & Walsh, 2000). In some cases, only the manage-
ment has an accurate idea of how many (nexus/alliance) rents are actually created
in the first place. If local government officials have many enterprises to supervise
and do not have time to participate in day-to-day operations, especially as is the
case in many 'Red Hat' firms, entrepreneurs/managers will be in an advantageous
position to distort the information available to the former. Specifically, due to the
underdeveloped capital market and lack of professional accounting practices in this
transitional period in China, they may make the firm's performance look worse
than it actually is to motivate the politicians to undertake privatization or a
management buyout (Chen, 2004; Liu et al., 2006). If the buyout price is based on
the book value of total assets rather than on a contingent basis, as the Midea case
suggests, they are very likely to obtain a discount by artificially lowering the book
value upon expectation of a management buyout. Based on this analysis, we offer
the following proposition:

Proposition 4: The higher the degree of information asymmetry between entrepreneurs and
politicians infirm operations, the larger the rent bargaining power of the entrepreneurs will be
relative to that of the politicians.

Break-up costs. Second, the cost of a potential break-up, which incorporates both
replacement costs and exit costs (Coff, 1999), can be high for both parties. In a
transitional economy like China's, the parties involved may underestimate
break-up costs as they have less experience dealing with break-ups than in a
developed economy. [7] However, in a bargaining context, it is the relative position
between the two parties that is crucial. We posit that the break-up cost is generally
higher for entrepreneurs/managers than for politicians. Since many entrepreneurs
retained their cadre status in parent government agencies, they are susceptible to
political retaliation if the bargaining breaks up ungracefully. Even absent retalia-

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 Entrepreneur-Politician Alliances and Management Buyouts in China 111

tion, the threat of exit by entrepreneurs is not very credible because of the firm-
specific investments they have made. Pardy owing to this asset specificity and pardy
to the underdeveloped managerial labour market in China, they have limited
outside options to recover the value of their human capital. For politicians, the cost
can be high if the original alliance collapses because they may not easily find
suitable and reliable outside replacements, and they may suffer major losses in
government financial revenue and private benefits. Nonetheless, the situation is less
devastating for politicians for two reasons. First, there is still a possibility of building
up new rent-generating alliances with outside investors/entrepreneurs. Second, as
supervisors of multiple enterprises in a locality, they have a greater capacity to
endure break-up losses than entrepreneurs. Thus:

Proposition 5: The larger the cost of a potential break-up to entrepreneurs than that to politicians
in their alliances, the larger the rent bargaining power of the politicians will be relative to that
of the entrepreneurs.

Contribution to previous rent generation. Third, a stakeholder's contribution to earlier

stages of rent generation can be important in determining its power in subse-
quent rent bargaining. Although Bowman and Ambrosini (2000) denied such a
relationship, the illustrations of Midea and Kelon strongly suggest otherwise.
Entrepreneurs significandy contribute to rent generation on account of their
entrepreneurial and managerial skills. The essential contribution of political
resources in the early stage of firm development is to equip politicians with
strong bargaining powers in subsequent rent appropriation, in spite of the
gradually declining value of the resources at their disposal in later stages of tran-
sition. In particular, if government agencies contributed financial capital at the
start-up stage, it is very challenging for entrepreneurs to change the dejure status
of ownership. In contrast, the absence of direct financial input from the govern-
ment makes it easier for the entrepreneurs to change the status quo of rent dis-
tribution. Hence:

Proposition 6: Tlie larger the contribution to previous rent generation by the politician or
entrepreneur, the larger the politician or entrepreneur's bargaining power will be.

Government andfinancial regulation. Fourth, management buyouts in China also high-

light the importance of the wider institutional environment in affecting the bar-
gaining powers of the two parties. It has been well recognized that economic
actions are embedded in a wide array of regulatory, normative, and cognitive
institutional parameters (Scott, 2008). Key among the regulatory parameters is
the central government, which sets the policy framework for management
buyouts. Generally speaking, the central state does not want to make a clear
distinction between these hybrids and traditional public enterprises. While

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 112 P. Sun et al.

turning a blind eye to insider privatization in township and village enterprises

and small local state-owned enterprises, it is against the use of management
buyouts in medium and large state-owned enterprises. Interestingly, however,
there was no well-defined management buyout regulation at the central level in
the late 1990s and early 2000s. The first comprehensive regulation - Provisional
Regulations on the Management Buyout of State-Owned Enterprises - was issued by the
State Asset Supervision and Administration Commission and the Ministry of
Finance in April, 2005.
Consequendy, the bargaining power of the grass-roots politicians is significandy
enhanced in the presence of supportive regulation, as entrepreneurs need to secure
local politicians' support as a political shelter from central intervention. Otherwise,
grass-roots politicians have an excuse to crack down on unilateral buyout attempts
on the grounds of enforcing central government policy.
Relatedly, financial institutions have a major impact on the financing of a
management buyout. A key difference between a privatization buyout in China
and a leveraged buyout in the West lies in the ease with which the management can
raise sufficient funds to finance their buyout (Wright, 2007b). Conventional chan-
nels such as commercial banks are controlled by the Chinese state, and their credit
decisions can easily be influenced by local politicians. Even without political
manipulation, management may still experience difficulty in providing collateral to
obtain bank funds, while a political helping hand could easily solve the financing
problem, as illustrated in Midea's case. Therefore, the bargaining power of grass-
roots politicians also relates to the extent to which they can affect bank lending
decisions (Park & Shen, 2003), which in turn affect entrepreneurs' financing
constraints.
The future bargaining position of management in these hybrid firms remains to
be seen, but it depends on whether political intervention in the banking system is
quickly diminishing and on whether they can find and effectively utilize new
financial partners such as private equity firms and foreign investors to bypass
domestic constraints. Summing up the impacts of the regulatory environment
discussed above, we propose the following:

Proposition 7: The tighter the regulation from the central government and the state-controlled
financial sector, the larger the bargaining power of the local politicians will be.

Legitimacy of management buyout practice. Regarding normative and cognitive factors,

institutional theory argues that economic actors and organizations are under heavy
isomorphic pressures to comply with prevailing institutional logics (DiMaggio &
Powell, 1983), such as legitimacy. According to Suchman (1995), legitimacy refers
to a legal and societal judgment of the appropriateness, image, and legal standing
of an organization and an agent's behaviours. Lacking legitimacy will reduce the
ability of organizations or agents to pursue their goals.

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 Entrepreneur-Politician Alliances and Management Buyouts in China 113

The current institutional environment in China seems a mixed blessing. On the

one hand, 'privatization' is no longer a political taboo, so entrepreneurs/
managers cannot be punished for the act of management buyout itself (Ahlstrom
& Bruton, 2001; Ahlstrom, Bruton, & Yeh, 2008). On the other hand, current
management buyout practices in China, characterized by the absence of open,
competitive bidding, the lack of third-party monitoring on asset evaluation, and
the clandestine nature of the whole process, are reminiscent of the notorious
nomenklatura buyouts in Eastern Europe (Filatotchev, Starkey, & Wright, 1994;
Frye, 2006) carried out by Communist Party functionaries who assumed control-
ling positions in the new enterprise. Indeed, management buyouts have been
treated by some populist media as synonymous with the dissipation of state assets
through insider self-enrichment, nothing more than another episode of wide-
spread corruption and social injustice. This public unpopularity of management
buyouts, whether justified or not, translates into a reduction of managerial bar-
gaining power: they may be weaker when negotiating a buyout deal with their
political partners because they have to rely on them to help overcome external
hostility. Hence:

Proposition 8: The lower the legitimacy of management buyouts as a form of wealth redistri-
bution in society, the smaller the bargaining power of the entrepreneurs will be.

Employees. Finally, the discussion of power differentials between entrepreneurs and

politicians cannot be isolated from the impacts of employees. In the Chinese
context, managers try to secure employee support by incorporating them as
new owners in real or symbolic terms. Specifically, management can create
a new collective entity - an employee shareholding association — as the proposed
new controlling shareholder of the buyout target. The association is not controlled
by trade unions and, in practice, is likely to be captured by the management.
Alternatively, they can establish a new holding company with significant employee
ownership (as illustrated by Midea) to acquire the target firm.
Employees do not necessarily always support privatization buyouts (Dong,
Bowles, & Ho, 2002). This is especially the case when the sale price in a manage-
ment buyout plan is too low to cover compensations for labour resetdement. If
their welfare benefits are seriously harmed in the restructuring process, employees
may voice their disgruntlement by staging demonstrations. The incidence of social
unrest, in turn, can immediately motivate the local politicians to stop a controver-
sial management buyout (Liu et al., 2006). Hence:

Proposition 9: The higher their ability to enlist the support of employees in a potential
management buyout, the larger the bargaining power of the entrepreneurs will be relative to that
of the politicians.

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 114 P. Sun et al.

The Intensity of Rent Struggle in Rent Appropriation Stages

As a specific rent distribution arises from the balance of bargaining powers between
stakeholder groups, Propositions 2 and 3 suggest that this distribution has consid-
erable impact on the intensity of rent bargaining in subsequent rent appropriation
stages, especially when a key stakeholder is dissatisfied with this distribution. In this
subsection, we explore other crucial factors that may determine the intensity of rent
bargaining in the rent appropriation stages.

Cognitive clash between entrepreneurs and politicians. One particularly relevant factor is
the evolving cognitive clash between entrepreneurs and politicians. As their alli-
ances grow, both parties have developed, to varying degrees, a 'proprietary atti-
tude' to the alliance rents (Francis, 1999). With respect to entrepreneurs, some may
perceive themselves as the real founders of the ventures and regard the existing rent
distribution as 'unjustified' during transition. Some may play down the politicians'
contribution by treating the initial affiliation as little more than a political expedi-
ency whereas others appreciate the continuing network value of the political
partners in 'their' firms.
As an illustration, Ning Pan at Kelon did not seem to value the contribution
from his political partners in the late 1990s, as he once contrasted his experience in
Hong Kong to that in the Mainland: 'When I am in Hong Kong, I can concentrate
on business and there is no special need of making friends with government
officials. But here I have no choice but to deal with the local politics.'18] In contrast,
our interviewees reported that Xiangjian He at Midea has a more 'realistic'
understanding of the role played by the local government even in the late stage of
transition.
On the part of politicians, some, especially those who have contributed financial
capital at the beginning, tend to adopt a legalistic view of firm ownership by
regarding the entrepreneurs as little more than the agents of normal public enter-
prises. Others, however, remain open-minded about future changes of ownership
form as long as their private benefits are retained. Consequently, a potential clash
of perceptions about the magnitude of their respective contributions to the gen-
eration of alliance rents could result in serious discontent about the extant rent
distribution and, thus, fiercer bargaining in the subsequent rent appropriation
stages.
In addition, entrepreneurs and politicians may estimate the costs of a potential
break-up during institutional reform differendy. Some entrepreneurs might believe
that they are integral to the firms and may reinforce their perception by comparing
themselves with other firms supervised by the same politicians. If the two parties'
beliefs about the break-up costs diverge over time, there tends to be a higher level of
ex post rent bargaining since each may believe that they can change the status quo in
their own favour. Alternatively, if their estimated break-up costs and, consequendy,

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 Entrepreneur-Politician Alliances and Management Buyouts in China 115

their perceived power balance are in agreement, the intensity of subsequent rent
struggle will reduce. In sum, cognitive factors relating to rent contribution and
break-up costs have profound impacts on the intensity of rent struggle:

Proposition 10: The intensity of rent struggle between stakeholders in subsequent rent appro-
priation stages will be positively correlated with the degree of their cognitive clash over the
importance of their respective contributions to rent generation and over the estimated costs of a
potential break-up.

Prospect of furtherfirmgrowth. Finally, such exogenous factors as the opportunities for

further firm growth may also affect the intensity of rent struggle. For example, if a
firm is located in an industry with good growth prospects, stakeholders may defer
the infighting even if some are not entirely happy with the current rent distribution.
They may expect themselves to be better off by quickly enlarging the potential
nexus rent. This is illustrated by the management buyout at TCL.
When Dongsheng Li and the Huizhou municipal government negotiated a
management buyout in 1997, T C L was enjoying fast sales growth due to the strong
domestic demand. Therefore, the parties reached the following agreement. The
existing stock of firm assets remained state-owned, but from 1997 onwards, man-
agement would be rewarded by share ownership according to the following rules:
if the annual growth in return on equity ranged from 10-25 percent, management
would obtain 15 percent of the annual equity increase; if the return on equity
growth rate lay between 25 and 40 percent, management would share 30 percent;
and if the return on equity grew more than 40 percent, management were able to
share 45 percent of the increase. Since TCL's average annual return on equity
growth rate was above 50 percent during the entirety of the 1990s, the municipal
government's stakes were gradually diluted. However, if the industry in which the
firm is located no longer offers great opportunities for further growth, the declining
prospect of future rent generation may act as a catalyst for more intense rent
appropriation. Hence:

Proposition 11: Tlie intensity of rent struggle between stakeholders in rent appropriation stages
will be negatively correlated with the prospect for further growth of the firm in question.

DISCUSSION

On a conceptual and methodological note, this research paper echoes the call
for contextualization in conducting Chinese management research (Tsui,
Schoonhoven, Meyer, Lau, & Milkovich, 2004; Whetten, 2009). Specifically, this
article not only helps extend the understanding of rent generation and rent capture
that has hitherto been studied in the context of developed economies, but also

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 116 P. Sun et al.

contextualizes the rent appropriation literature by focusing on the evolution of a

unique type of indigenous organization - entrepreneur-politician alliances. This is
consistent with the 'inside out' approach requiring contextualization of the phe-
nomena for study (Tsui, 2006).
We generalize the contextually rich phenomena by building a theory of
entrepreneur-politician bargaining, which could be potentially applied to analyse
other types of stakeholder bargaining in other emerging markets. Such emerging
markets have become fertile grounds for developing new theories (Wright,
Filatotchev, Hoskisson, & Peng, 2005).

Limitations and Future Research Directions

Our propositions have taken a general view of entrepreneurs and politicians,

ignoring the potential heterogeneity within the two groups. For example, some
managers may be more entrepreneurial than others and place more emphasis on
firm growth than on cost reductions and efficiency improvements (Wright et al.,
2000). In addition, political shrewdness and skills may vary considerably among
indigenous entrepreneurs, and such a variance may influence the bargaining
outcomes significandy.[9J With respect to politicians, they may also be heteroge-
neous in terms of their seniority, strategic agendas, and attitudes towards entre-
preneurial activities. There may also be heterogeneity in bargaining behaviour
between politicians and the various firms they supervise. Further theoretical and
empirical research should consider exploring the implications of this heterogeneity
for the stability of entrepreneur-partner alliances and the successful completion of
management buyouts.
The propositions developed in this paper should be empirically verified by further
detailed case studies and large-scale surveys of firms. Our discussion of dynamic
interactions between entrepreneurs and politicians also highlights a need for more
longitudinal and process-based studies. Future research may explore how entre-
preneurs' political strategies evolve with the steady change of China's institutional
environment. Given earlier studies of Chinese firms on this front (Tan & Litschert,
1994; Tan & Tan, 2005; Tan, Yang, & Veliyath, 2009), detailed empirical work
examining environment-strategy co-evolution in buyout firms and entrepreneurial
start-ups is in order. Additionally, scholars may be interested in the life-cycle
trajectory of these firms. Do buyout entrepreneurs remain owners of the firms over
the longer term or subsequendy sell the firms to outsiders? Such analysis would
provide an interesting contrast to the conventional Western debate regarding the
longevity of management buyouts (Wright, Robbie, Thompson, & Starkey, 1994).

Policy Implications

The efficiency and legitimacy of ongoing privatization buyouts in Chinese indus-

trial sectors have been a very controversial and even an emotional issue in both

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 Entrepreneur—Politician Alliances and Management Buyouts in China 117

academic and policy communities (Lang, 2006). This paper offers fresh per-
spectives that seek to go beyond the emotional level to achieve a more analytical
understanding of management buyouts in China that can lead to policy
development.
T o some extent, similar issues have also arisen in the West as well as in other
transition economies. Important influences on the development of management
buyout policy have been the consideration of the trade-offs between rent capture
and the evidence on improved efficiencies and legitimate entrepreneurial activi-
ties (Wright, 2007a). Rather than banning buyouts, policy evolved to incorporate
mechanisms that can enable the state and other stakeholders to capture some
rents. For example, retained equity stakes by the state, performance-contingent
pricing, contractual provisions that enable the state to share in any subsequent
gains relating to real estate disposals by the buyout managers (claw-back mecha-
nisms), requirements for wider employee share ownership, etc. became standard
features of privatization buyouts in the U K (National Audit Office/CMBOR,
1991).
Central government policymakers in China who care about sustaining the
competitiveness of indigenous businesses need to be aware of the complex dynam-
ics of the alliances and to design ground rules regulating the delicate bargaining
process. Policymakers concerned both with stimulating economic development in
emerging markets as well as with regulating potential abuses need to understand
where and how rents are generated and avoid squeezing out the former in their
attempts to deal with the latter. In addition, politicians with several subordinate
firms may need to recognize that the bargaining outcomes regarding rent appro-
priation with respect to one management buyout attempt may have implications
for other firms supervised by the same state agency. It is also clear that foreign firms
competing or cooperating with Chinese businesses need to monitor the continuing
development of entrepreneur-politician interactions.

CONCLUSION

This article offers a model describing the dynamic processes by which entre-
preneurs interact with politicians in transitional China through the lens
of management buyouts. Focusing on the evolutionary paths of Chinese
entrepreneur-politician alliances, the model integrates the indigenous context
and the rent appropriation literature to identify the evolving bargaining powers
of the two parties, the intensity of bargaining over organizational rent, and
the eventual stability of the partnership. The model sheds light on the complex
determinants of when management buyouts in China would succeed and when
they would not. We hope this study adds one more piece to the large puzzle on
the role of government and politicians in the life of private enterprises and
private entrepreneurs.

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 118 P. Sunetal.
NOTES
We are indebted to Anne Tsui, Justin Tan, two anonymous reviewers of the journal, Guy Liu, and
the audiences for our presentations at the third IACMR Conference in Guangzhou, China, June
2008, and at the Strategic Management Society 28th Annual Conference in Cologne, Germany,
October 2008, for their valuable comments on earlier versions of the paper. Financial support from
China's national '211 Project' (project code: 21 lxk06) and Nottingham University Business School is
greatly appreciated.
[1] Founded by Huizhou municipal government in Guangdong Province and a group of enterprising
individuals in 1981, TCL has become the world's biggest colour TV maker by acquiring
Thomson's TV division in 2004.
[2] Currendy the third largest white goods manufacturer in the world, Haier originated from an
urban collective plant under the control of the Qingdao municipal government. Haier took off
after 1984 when Ruimen Zhang, then a mid-level official in the Qingdao government, was
appointed as director of this firm.
[3] Information on Midea is largely based on interviews we conducted in April, 2006.
[4] Owing to the absence of developed capital markets, valuation of firm assets in transition econo-
mies is a well-known problem. Previous studies (e.g., Liu et al., 2006) showed that net asset
pricing is popular in China. That is, the sale price is, in general, set to equal the difference
between the book value of a firm's total assets and the sum of its depreciation and total debts
outstanding. Expecting an MBO in the future, the management will have strong incentives to
understate the book value. A further discount on the basis of the possibly understated book value,
as illustrated here, implies significant rent capture by He and his associates.
[5] The following description of Kelon draws on Huang and Lane (2001) and Liu and Sun (2006).
[6] The US dollar numbers are obtained using the official exchange rate in the 1980s, when the
RMB was heavily overvalued (rather than undervalued since early 1990s) by the central govern-
ment. For example, the official exchange rate in 1985 was %\ = RMB 2.94, though the effective
rate was much higher on the underground market. The numbers, including the US dollars, are
originally from Huang and Lane (2001).
[7] We thank an anonymous reviewer for offering this interesting observation.
[8] This quotation is from the transcript of a Chinese scholar, who interviewed Ning Pan in the late
1990s.
[9] We thank an anonymous reviewer for offering this valuable insight.

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 Entrepreneur-Politician Alliances and Management Buyouts in China 121

Pei Sun ([email protected]) received his Ph.D. in Business and

Management Economics from Judge Business School, University of
Cambridge, UK. He is Associate Professor in Industrial Economics at the
School of Management, Fudan University, China. His research interests
concern corporate governance, firm strategy, and industrial organization in
emerging economies, especially China. His research papers have appeared in
journals such as Cambridge Journal of Economics, Economics Letters, and World
Development.
M i k e Wright ([email protected]) earned his Ph.D. at
Nottingham University where he is Professor of Financial Studies and
Director of the Centre for Management Buyout Research. His research
focuses upon private equity, entrepreneurship and emerging economies. He is
an associate editor of Strategic Entrepreneurship Journal and consulting editor of
Journal of Management Studies.
K a m e l Mellahi ([email protected]) earned his Ph.D. at the
University of Nottingham. He is Professor of Strategic Management and
Head of Management Division at Sheffield University Management School.
His research focuses on management in emerging economies, non-market
strategies and organizational failure. He has over 50 papers published or
accepted for publication in such journals as Strategic Management Journal, Journal
of International Business Studies, Journal of Management Studies, Long Range Planning,
International HRM, Journal of World Business and British Journal of Management. He
has provided policy advice to numerous public and private organizations.

Manuscript received: July 7, 2008

Final version accepted: August 17, 2009
Accepted by: Justin Tan

©2010 Blackwell Publishing Lid

https://doi.org/10.1111/j.1740-8784.2009.00157.x Published online by Cambridge University Press