(Al)ready made: Incentives in US and Chinese Corporations

Excelent point made by twofish:

You need to ask what situation personally benefits the managers that make decisions.
With Chinese companies, the more money you have in your bank account, the higher the salary and benefits of the managers.
If you have large amounts of cash in the bank, you are more able to pay yourself large salaries and give yourself a better car. It doesn’t matter to the management where the cash comes from, but as banks have tightened lending, it becomes harder to use bank loans to create large cash accounts, so the tendency has been to hoard cash from operations. Also it’s not the ratio that matters but the absolute amount of cash. You can have company with huge amounts of cash, but even larger amounts of debt.

By contrast, American managers are rewarded if they have high stock prices and high stock prices come from having large amounts of return on equity. This encourages American companies to borrow heavily and have as little in cash reserves as possible. Also US corporate law makes if very dangerous for a large company to have large amounts of cash because any company with huge amounts of cash is susceptible to a leveraged buyout.
The theory behind American corporate governence is that by rewarding companies based on profitability you are encouraging efficient use of capital, unencouraging people not to keep capital and to move capital from low return uses to high return uses.

The problems with this idea are that:
1) you get high returns by boosting risk, and by boosting risk, you are putting the people you are borrowing from at risk
2) if you are highly leveraged, you are very vulnerable to economic shocks, and
3) this sort of structure encourages people to borrow short term liquid instruments to fund long term illiquid investments, once this funding runs out, you are in some serious trouble.
My belief is that Chinese companies and banks will find themselves in better shape than American companies and banks because the companies that were not shut down have large supplies of cash and hence are more shock resistant. Being shock resistant is important since it gives you time.
If you are highly leveraged, you could go from seemingly healthy to dead in a few days (see Bear-Stearns and Lehman Brothers) and if you have an economy which is highly leveraged you run the risk of a domino effect that can bring down the entire financial system. By contrast, if you have a lot of cash, and something bad happens, you have a few weeks, months, or in some cases years, to do something about it.