Farewell, Red Hats(3)

According to IMC research, in 2005 only 0.24 percent of collectively-owned businesses changed their status. This is likely because of difficulty regarding property rights.

During the nineties, especially in Jiangsu province, many property rights disputes were settled through Management Buyouts (MBO). Jiangsu's Sha Steel is a classic example. But other times it only came after protracted lawsuits that ultimately led to the collapse of the business, with the initial investors forced out.

Zhang explains why: "It's simple: If the original investor leaves with profits and the business is ruled as a collective-owned, then that investor will be accountable for the embezzlement of public funds. Only if it is ruled as a privately-owned business will have the right to have done so... If during the process the initial investor does not properly compensate interested parties, it will end tragically." Ma Guangyuan, an attorney from Shanghai Tongli Law Firm, adds, "This kind of company can be found everywhere."

Thus, businesses are now looking for flexibility. Ma recently represented a junior branch of a publishing house. At that time it was not possible for a private investor to run a publishing company so they used the larger publishing house as an umbrella. As a result of the restructuring process, the original investor only retained a 30 percent share in the firm while the publishing house retained 40 percent.

Ma predicts that Red Hats won't be around for long. "Many people have gone through difficult times. The current Thirty-six Conditions are not good, with many markets impenetrable for private businesses. Investors will not be able to avoid problems with murky ownership status, and will thus choose to invest in state-owned companies instead.'

But just because the Red Hats are becoming history doesn't mean that Chinese firms won't wear another kind of hat instead. More and more companies are registering abroad in places like the Isle. of Man while simultaneously managing their firm domestically. "They're looking for protection and favorable policy." says Zhang.

Perhaps this is not so strange after all. But if companies start wearing "Sea Hats", when will they start taking them off?