bmg.gifManagement books tell multinationals to let local Chinese executives handle the day-to-day operations of their China offices. Compared to parachuting in westerners who struggle to understand the strange language and even stranger business culture, the advantages of using local managers seem obvious.

But in China, a trusting hands-off management style risks being interpreted as a weakness on the part of the western parent. A weakness which unscrupulous local managers may try to exploit, as Germany's Business Media China discovered to its cost.

In June, the Frankfurt-listed company, which specialises in exhibitions and billboard advertising, uncovered a massive fraud at its Beijing headquarters. A group of BMC's senior Chinese managers had – unbeknown to BMC's German managers – set up their own company within BMC and syphoned off its most lucrative advertising contracts, according to the Financial Times.

Beijing police are now investigating.

Business Media China was set up in 2004 by Klaus Hilligardt, a 67-year-old businessman from Stuttgart who sold his German advertising and exhibition company in the late 1990s to focus his attentions on China's then nascent advertising and exhibitions sector.

Hilligardt believed in putting local Chinese in charge of his business, not only because they spoke the language and understood the market but because they had connections and got things done. He told the FT:

My management philosophy was one of mutual trust and harmony, a merging of European quality standards and discipline with Chinese drive and knowledge of the market. I realise now that the key to everything in China is not harmony but control.”

Hilligardt did not speak Mandarin and so he entrusted a young Chinese executive, Li Yangyang, to run the business and he let his secretary take charge not just of his personal affairs but also business dealings and investments.

Li married the secretary and recruited many of his former university classmates into the firm, creating an inner circle that grew to exert a dangerously level of influence on the company but with Mr Hilligardt's apparent blessing. One BMC employee told the FT:

He was a vain old man who trusted the wrong people. They built up a world around him in which he felt safe and he didn't see the problems in the business because he didn't want to see them.”

But the German parent began to worry about the running of BMC's China office in late 2008. Revenues from contracts for its billboards fell precipitously, but the Chinese office kept requesting more funds from the German parent. The company lost confidence in Hilligardt and made him retire from the board. In his place, it appointed a Swiss executive who, like Hilligardt, was an old Asia hand, to try to stem the mounting losses.

The new CEO was tipped off anonymously about the “inner circle” syphoning off advertising contracts that previously belonged to BMC. He mounted a raid and found marketing material and other documents indicating that seven employees of the company's advertising subsidiary, including Li and his former classmates, had set up a shadow business in August 2008, called BMC Heli.

This company even used a logo that was almost identical to that of BMC. Needless to say, those outside the inner circle were unaware that anything was wrong.

They were told by Chinese executives involved with the new company that the German parent had set up a new subsidiary and that all advertising contracts were now to be signed with BMC Heli.

While the shadow company booked all the revenues, the parent was paying BMC Heli's operating costs and most of the rogue employees' salaries.

As details of the case emerged, Hilligardt claims to have discovered evidence that his trusted secretary had used fake receipts to embezzle nearly €1m in the process of purchasing two imperial courtyard houses in Beijing on his behalf. The secretary is now in police custody.

So what's the take-home? A humbled Hilligardt told the FT:

If I had to do it again I would put foreigners in charge of my business rather than Chinese. If I'd only fired my secretary on the day of her wedding then none of this would have happened.”