A principal–agent analysis of China's sovereign wealth system: Byzantine by design

ABSTRACT The paper provides an explanation for a puzzling aspect of China's nascent sovereign wealth system, namely the ever-more obvious competition between China's officially designated sovereign wealth fund (SWF), the China Investment Corporation (CIC), and the foreign exchange reserve management agency, the State Administration of Foreign Exchange (SAFE). We outline an analytical framework which illuminates the various pathways by which state leaders seek to address a principal–agent problem common to all sovereign wealth funds. We suggest that state leaders select corporate governance regimes that mesh with what we call the state's ‘governance endowments’. We then substantiate the claim that China's particular governance endowments have led China's leaders to embrace a corporate governance model premised on competition among the state's sovereign wealth investors. We trace the intense bureaucratic conflicts that shaped the creation of CIC and then show how SAFE was subsequently drawn into competition with CIC in the area of high risk, high yield investment. Although China's SWF tournament emerged as a quite unintended consequence of bureaucratic politics, China's leadership has since tacitly endorsed this rivalry because it has supplied the government with valuable carrot and stick mechanisms with which to discipline fund managers.