In a society based on collectivism, being a member of a close and committed group is vital. Since the Chinese approach relationships with the belief they will develop over time, and admire respect, loyalty, and trust, there is no such thing as a purely business relationship. Building mutually beneficial relationships is the core of Chinese business.
The Chinese prefer to work with those they trust and have personal relationships with. Guanxi is the Chinese term for relationships. Guanxi, in the corporate world, is a network of relationships that support one another. To build Guanxi, it is expected that you treat others with decency, and be a trustworthy and dependable person.
Guanxi is also a sense of mutual obligation and reciprocity. People with Guanxi will do favors for members in their network, such as, acting on another’s behalf and doing whatever is necessary for the other party. When a favor is complete, reciprocity is expected. It doesn’t have to be in like kind, but an effort must be made. If you are unable to meet your obligation, you must find another way to fulfill a favor or request.
Guanxi is also used to ensure mutual obligations are met. Meeting obligations through Guanxi is especially important in China because contracts are not reliably enforced. .
Investors in US-listed China stocks are now facing problems because we don’t understand Guanxi. The trading halts of China Intelligent Lighting (NASDAQ:CIL) and NIVS IntelliMedia Technology (NIV) are recent examples of how things can go wrong.
Most of us don’t have Guanxi because we do not know anyone. Since foreign investors’ do not know anyone in the Guanxi network, investments often turn sour because the red flags regarding the trustworthiness of management are not received. If we had been in the Guanxi network, we would have known otherwise.
Investors can become targets to those with dishonest intentions. According to some experts many Chinese RTO and IPO transactions in the U.S. are ego-driven and undertaken only to build the resume of local country management.
I wrote some positive articles about China Intelligent Lighting (CIL) and NIVS IntelliMedia Technology (NIV), because I really thought those were legitimate companies.
The main problem with NIV and CIL is too much Guanxi: they share the same facilities, same auditor, and there are many connections within senior management (founders, directors).
Another article I would recommend about this debacle is called WestPark Capital's RTO Deals http://china.fixyou.co.uk/
Disclosure: I am long CIL, NIV.