The sooner an effective incentive mechanism is brought into place, the faster China's State-owned enterprises (SOEs) will press ahead with their market-oriented transformation.

However, the immaturity of China's market economy requires extra caution from the supervisors when they design incentive schemes for SOEs.

The State-owned Assets Supervision and Administration Commission (SASAC) said it will soon release a stock option incentive scheme for top management at the country's 166 central SOEs.

Such an incentive plan will help place the management's compensation directly in line with the companies' long-term performance while exposing them to investors' scrutiny. As China lists more and more SOEs in overseas and domestic stock markets, public shareholders will play an increasingly important role as external supervisors.

At present, the performance of top management at large SOEs is mainly assessed by the SASAC, an authority the State Council established in 2003 to supervise the preservation and appreciation of State-owned assets.

Six of the 166 central SOEs failed to pass the SASAC's annual assessment due to serious workplace accidents, poor performance and accounting fraud in 2005.

Subsequent punishments, such as salary cuts, delivered by the supervisory body will undoubtedly serve as a warning for other unqualified managers as well.

Though the 160-odd central SOEs altogether made a profit of 627.65 billion yuan (US$78.45 billion) last year, the top 40 firms contributed 95 per cent of the gain.

In other words, most large SOEs still do not fare well after years of reorganization and restructuring. In fact, 11 were still making losses in the first half of this year while central SOEs' total profits surged by 16 per cent year-on-year and hit a record high in June.

Compared with the difficult times during the late 1990s when many State firms were on the verge of bankruptcy, the current performance of large SOEs is much more remarkable thanks to previous painful reforms.

Yet measured in terms of their weight in the national economy, central SOEs, as a whole, still have a lot to do to improve their management and efficiency.

The SASAC's effort to introduce a stock option incentive scheme is obviously part of the answer.

Similar incentive schemes in developed economies have often significantly boosted the management's compensation to raise their stake in the company's sound growth.

Nevertheless, given the nature of State-owned assets and the immaturity of China's market economy, it is necessary to devise the incentive plan very carefully.

The SASAC must ensure that incentive reform will not become merely a chance for the management to hike their compensation at the cost of State-owned assets.

Meanwhile, the reform should also work to better match the management's payment with their responsibilities.

Since the value of the stock option will be decided largely by investors' endorsement of the company's performance and prospect, the new incentive scheme is highly market-oriented. In implementing it, the management should be encouraged to improve SOEs' efficiency by adapting them to fierce market competition without relying on State protection.