Are U.S.-Listed Chinese Firms a Minefield? A Board Perspective

• Author: Chao Xi, Yurong Huang
• Pages: 201-246

Are U.S.-Listed Chinese Firms a Minefield?

A Board Perspective

C

HAO

X

I

*

AND

Y

URONG

H

UANG

**

I. Introduction

In the midst of the ongoing Sino-U.S. tensions, a remarkable flashpoint

was the massive corporate scandal of Luckin Coffee (Luckin). Luckin,

Cayman Islands incorporated, NASDAQ-listed Chinese company, operated

the largest coffee chain in China measured by stores and was touted as an

upstart rival to upend Starbucks’ dominance in the Chinese market.

1

Founded in 2017, Luckin went public in May 2019, making it one of the

fastest companies in the world to go from founding to initial public offering

(IPO).

2

Into the eleventh month of its run as a publicly traded company,

however, Luckin shocked the market in April 2020 with the disclosure that it

had fabricated much of its reported sales.

3

It came under investigation of

regulatory authorities both in China and the United States,

4

eventually

leading to its delisting from NASDAQ in July 2020.

5

Its market

capitalization plunged over 53 percent from an all-time high of $12 billion in

* Professor and Associate Dean (Research); Chair, CCTL Corporate Law and Governance

Cluster, Faculty of Law, the Chinese University of Hong Kong. This research has been

supported by a General Research Fund (CUHK- 14605218) from the Hong Kong SAR

Research Grants Council. The Law is stated as of September 30, 2020.

** Doctoral Researcher, Faculty of Law, the Chinese University of Hong Kong. Admitted to

the New York State Bar.

1. Jing Yang, China Moves to Punish Luckin for Fabricating Sales, W

ALL

S

T

. J. (July 31, 2020,

7:59 AM), https://www.wsj.com/articles/china-moves-to-punish-luckin-coffee-for-fabricating-

sales-11596196761 [https://perma.cc/8QKM-7932].

2. Id.

3. Quentin Webb & Joanne Chiu, Ernst & Young Says It First Found Accounting Issues at

Luckin, W

ALL

S

T

. J. (Apr. 3, 2020, 11:23 AM), https://www.wsj.com/articles/ernst-young-says-

it-first-found-accounting-issues-at-luckin-11585927403 [https://perma.cc/XNP2-7WAH].

4. Jing Yang, Luckin Coffee Under Investigation by China’s Top Commerce Regulator, W

ALL

S

T

. J.

(Apr. 27, 2020, 8:02 AM), https://www.wsj.com/articles/luckin-coffee-under-investigation-by-

chinas-top-commerce-regulator-11587967299 [https://perma.cc/H4EC-LMFJ]; Dave

Michaels, SEC Investigates China’s Luckin Coffee over Accounting Scandal, W

ALL

S

T

. J. (Apr. 29,

2020, 5:30 AM), https://www.wsj.com/articles/sec-investigates-starbucks-china-rival-luckin-

over-accounting-scandal-11588152604 [https://perma.cc/9M78-57WZ].

5. Jing Yang, Luckin Coffee Drops NASDAQ Appeal; Shares to Be Delisted, W

ALL

S

T

. J. (June

26, 2020, 8:36 PM), https://www.wsj.com/articles/luckin-coffee-drops-NASDAQ-appeal-

shares-to-be-delisted-11593188282 [http://archive.md/20200803015642/https://www.wsj.com/

articles/luckin-coffee-drops-NASDAQ-appeal-shares-to-be-delisted-11593188282].

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202 THE INTERNATIONAL LAWYER [VOL. 54, NO. 2

January 2020 to $350 million in June 2020,

6

saddling institutional and

individual investors both in Asia and the West with heavy losses.

In the wake of Luckin’s scandal, the U.S.-listed Chinese companies as a

group have been seen as posing particularly significant risks to investors in

the U.S. stock markets. The U.S. Securities and Exchange Commission

(SEC) warned, with an unambiguous reference to China, that “there is

substantially greater risk that disclosures will be incomplete or misleading

and, in the event of investor harm, substantially less access to recourse, in

comparison to U.S. domestic companies.”

7

A bill passed unanimously the

U.S. Senate in May 2020 to, in effect, give U.S.-listed Chinese companies

three years to comply with the U.S. audit requirements or to give up their

U.S. listings.

8

The House was said to be likely to approve the Senate bill,

9

and the Trump administration has reportedly drawn up a plan to follow on

the bipartisan legislation.

10

Calls have even been made to bar new listings

from China altogether.

11

Are the U.S.-listed Chinese firms, as a group, truly a corporate

governance minefield to be avoided at all costs? Did the Luckin scandal

reveal the commonly shared, deep-rooted governance deficiencies of the

New York Stock Exchange (NYSE) and NASDAQ-listed Chinese firms or

was Luckin an outlier? Much of the focus on the current debate has been,

perhaps deservedly, on the decade-old issue of access to the audit papers

located in China, an issue known for its political intricacy and complexity.

12

The current Sino-U.S. confrontation has made the issue, albeit important,

6. Id.

7. Public Statement, SEC Chairman Jay Clayton et al., SEC, Emerging Market Investments

Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies Are Limited

(April 21, 2020), https://www.sec.gov/news/public-statement/emerging-market-investments-

disclosure-reporting [https://perma.cc/4UM6-DM2V].

8. Dave Michaels, Chinese Companies Could Be Forced to Give Up U.S. Listings Under Senate

Bill, W

ALL

S

T

. J. (May 20, 2020, 7:48 PM), https://www.wsj.com/articles/chinese-companies-

could-be-forced-to-give-up-u-s-listings-under-senate-bill-11590015423 [http://archive.md/

20200521181923/https://www.wsj.com/articles/chinese-companies-could-be-forced-to-give-

up-u-s-listings-under-senate-bill-11590015423].

9. Dave Michaels & Akane Otani, U.S. Moves to Audit Chinese Firms. Market Frets Over What

Comes Next, W

ALL

S

T

. J. (May 26, 2020, 5:30 AM), https://www.wsj.com/articles/u-s-moves-to-

audit-chinese-firms-market-frets-over-what-comes-next-11590485401 [https://perma.cc/

APR2-R9TG].

10. Dave Michaels, White House Seeks Crackdown on U.S.-Listed Chinese Firms, W

ALL

S

T

. J.

(Aug. 6, 2020, 8:06 PM), https://www.wsj.com/articles/trump-administration-seeks-crackdown-

on-chinese-companies-with-shares-traded-in-u-s-11596748284 [https://perma.cc/HG5D-

7SV5].

11. Jesse Fried, Delisting Chinese Companies Plays Straight into Their Hands, F

IN

. T

IMES

(June 1,

2020), https://www.ft.com/content/7bb80406-a0c6-11ea-ba68-3d5500196c30 [https://

perma.cc/M3H7-8BWR].

12. Id; See Rohan Maitra, Scaling Two Great Walls: Resolving the Impasse Between China’s State

Secrets Law and International Disclosure Requirements, 36 N

W

. J. I

NT

’

L

L. & B

US

. 587, 591 (2016);

See also, Qingxiu Bu, The Chinese Reverse Merger Companies (RMCs) Reassessed: Promising but

Challenging?, 12 J. I

NT

’

L

B

US

. & L. 17, 17 (2013).

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2021] ARE U.S.-LISTED CHINESE FIRMS A MINEFIELD? 203

all the less likely to be resolved in the near future. It is useful, therefore, to

direct our attention to an alternative and potentially productive venue: the

corporate board. A wealth of literature has shown that independent boards

and board committees help to ensure the integrity of the corporate financial

reporting processes.

13

Board independence has also been a focal point of the

corporate governance reforms sweeping across the globe in the past two

decades.

14

The board perspective, which has remained under-studied in

respect of the U.S.-listed Chinese firms, promises to offer another lens

through which the current issues can be further debated.

15

Drawing upon two unique, comprehensive datasets we have created

specifically for this research, this research sheds fresh empirical light on

some previously little-known characteristics and patterns of the U.S.-listed

Chinese listed companies and, in particular, their boards and board

committees. We show empirically that Luckin’s board and board

committees were among the least independent in the group of NASDAQ-

listed Chinese firms. We therefore caution against judging the whole group

of U.S.-listed Chinese companies on the basis of what appears to be an

outlier firm. Our research also empirically demonstrates that the Chinese

companies listed on the NYSE and NASDAQ, on average, have fewer

independent boards and board committees than S&P 500 and Russell 3000

firms do.

16

Care should be taken in interpreting this finding. Overall, our

research does not offer much support to the views categorically labelling the

whole cohort of the U.S.-listed Chinese firms as a minefield insofar as

board-level governance is concerned.

The rest of the article is structured as follows: Part II provides a detailed

empirical account of the universe of U.S.-listed Chinese firms, drawing upon

a unique dataset of their firm characteristics. Part III depicts the role of the

board and board committees in corporate governance in general and

highlights the issue of independence in particular. Part IV proceeds to

elaborate on the board and board committee rules applicable to the U.S.-

listed Chinese firms. Drawing upon a proprietary, hand-collected dataset on

the boards and board committees of the NYSE- and NASDAQ-listed

Chinese firms, Part V addresses the two key empirical questions set out

above. Part VI offers conclusions.

II. U.S.-Listed Chinese Firms: An Empirical Survey

Since the early 1990s, Chinese firms have successfully listed on prime

overseas stock exchanges globally, inter alia, in Hong Kong, New York,

13. See Ren´ee B. Adams et al., The Role of Boards of Directors in Corporate Governance: A

Conceptual Framework and Survey, 48 J. E

CON

. L

ITERATURE

58, 96 (2010). See also discussion

infra Section III.

14. See id. at 81.

15. See id. at 96.

16. See generally Appendix 1.

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