Transcript Law and Finance vs. Administrative Governance: The Case of China

Law and Finance vs.
Administrative Governance:
The Case of China
Chenggang Xu, LSE and Tsinghua University
Based on
Julan Du and Chenggang Xu, International Economic Association Round Table, 2005
Katharina Pistor and Chenggang Xu, American Law and Economics Review, 2005
China vs. Law&Finance Literature
• General discoveries on law and finance:
– good law as necessary condition for financial development
• Better law in books (shareholder protection) (La Porta et al., 1997; 1998)
• Better law enforcement (Johnson et al., 2000; Pistor et al., 2000)
• Law and finance in China looks opposite
– Better financial performance than average transition economies
• Higher than average in market capitalization and market liquidity
• Substantially more IPOs and raised much more funds
– 873 IPOs in 1994-2001 (the best in other TEs: Poland: 47)
» much more than the total of the EE-FSU markets
– Raised 61.6 billion US$ from markets in 1998 and 2001
» much more than the total of the EE-FSU markets
– Worse law and enforcement:than average transition economies
Financial market performance:
EE-FSU vs. China
Total Mkt
Cap/GDP
Tradeable Mkt Turnover
Cap/GDP
ratio
Aggregate
EE-FSU
0.2
0.12
25
China
0.4
0.16
68
Administrative Governance
as a substitute for legal governance
• Chinese financial development did not happen in a
governance vacuum
• Administrative governance substitutes for formal legal
governance in transition
• Institutional condition of the administrative governance:
– Regional decentralization
• Quota system (1994-2002) at jump-start stage of
securities markets
– Decentralized information collection/revelation process
– Provides incentives for information collection
Poor statutory law in China
• General description
– China dismantled the formal legal system before the reforms
(the Cultural Revolution) – uniquely bad
• Had to build legal system from scratch
– No protection to private property rights in the constitution
until Apr 2004
– The corporate law (1994) was designed for SOEs
• silent on private ownership
• Cross country comparison
– Statutory law: below average (TEs) in shareholder protection
– Law enforcement (perception data): below average (TEs)
– Almost by any measurement China’s law is below average,
some times far below average
Marginal roles of
formal legal governance
• Absence of private enforcement (courts restricted)
– Supreme court announced not to take cases related to
security markets till 2002
– Since 2003: take cases only for misrepresentation of
information – not for insider trading or market
manipulation
– Not a SINGLE civil law case has resulted in liability
imposed by a court
• Inactive public enforcement
– From 1993-2001, 94% regulatory enforcements had
no punishment (60% were ‘internal criticism’)
Function of Quota system
• Originally designed to control the size of financial
markets
• Under regional decentralization/competition it
becomes a de facto governance mechanism
– As information system
• Generates company information from “insiders”
• Reduces worst “lemons”
– As incentive system
• To disclose information truthfully
Chinese Economy:
Regional Governance Structure
Central Gov't
Province A
SOE A1
SOE A2
Province B
SOE B1
SOE B2
Regional governments and their firms
• Most SOEs in China are regional
• Regional governments are ‘owners’ of regional
SOEs
– Better informed than others about ‘their’ firms
• Regional SOEs are major (or important)
financial resources of regional governments
• Regional competition (e.g. in growth rate)
– Incentives to help regional SOEs
Operation of quota system
Central Government
Regional Governments
Determines National/regional
Quota (# of shares to be issued);
Allocates quota to regions
Allocate quota to selected SOEs ;
Collect/Send info on these SOEs
Admitted Companies
IPO in markets
CSRC
Reviews company info;
Companies admitted
Quota System as Information System
• Severe information problem in markets at IPO stage
• Mandatory disclosure rule as a solution for countries
with rule of law and with other markets
• China: lack of rule of law; underdevelopment of
markets
– Ineffective in transplanting standard legal system
• Quota system: decentralized information collection
– allocated the responsibility for collecting and verifying
information to the ‘owners’ of firms – regional governments
Quota system provides incentives
for disclosure
• For regional benefits regional governments may
cheat
– need governance structure
• The quota system created an incentive structure
– Carrots to regional governors in the form of future
quotas
– Future quota allocations to regions are related to past
performances of companies from the regions
– Testable hypothesis
Quota Allocation (97-99) vs.
Earlier Market Cap (94-96)
Guizhou
13.782
•
Gansu
Hunan
Stock Quota
Jilin
Hebei
Xinjiang
Ning xia
Shanxi
Innermon
Shandong
Zhejiang
Hubei
Beijing
Heilong j
Shaanxi
Yunnan
Fujian
Guang
xi
Jiang
xi
Liaoning
Chong qin
Henan
Sichuan
.413074
Hainan
Guang don
Shanghai
Anhui
jiang su
Tianjin
.750212
35.6099
Grow th in Market Cap
Quota Allocation (97-99) vs.
Earlier Net Profits (94-96)
Guizhou
13.782
Gansu
Hunan
Jilin
Stock Quota
Hebei
Xinjiang
Shanxi
Ning xia
Innermon
Shandong
Zhejiang
Hubei
Liaoning
Beijing
Heilong j
Shaanxi
Fujian
Guang xi
Jiang xi
Henan
Hainan
Guang don
.413074
Yunnan
Chong qin
Sichuan
jiang su
Tianjin
Shanghai
Anhui
-.769484
1.9523
Grow th in Net Profits
Punishments to
under-performed regions
• Delisting firms => loss of quota for the region
– No other company could step in and use the quota to
issue its shares
• Delisting can be combined with reduced future
quota allocation
– Guangdong had the largest number of de-listed firms
since 1999
• received a low quota since 1999
• performed substantially below the national mean and median
in 1996-99
Problems cannot be addressed by
quota system
• Non-state firms
– Regional governments have no informational advantages
– Incentives to regional governments by the quota system do
not help
• Continuous disclosure
– Different roles of regional governments on IPO and
continuous operation
– Change of corporate governance after IPO – separating
regional government from state-owned firms
• As a purpose
• In reality
Continuous Disclosure Problem
Conclusion
• Quota system as a decentralized administrative governance
mechanism as a substitute for ‘standard’ legal governance
at the IPO stage for jump-start stage
• Political economy of initial choice and modification
– Building on existing institutions
– Institutionalization of collaboration (no separation of power)
• The relative success of the quota system does not imply its
superior to a standard legal regime in the long term
– No law land trap: Danger of slowing down in establishing rule
of law
– Biggest problem in introducing standard legal regime:
independence of judicial system
• General lessons for financial regulation in emerging
markets