Law, Finance, and Financial Regulation in China

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

• Regional Governments
• Allocate quota to selected SOEs ;
• Collect/Send info on these SOEs

• Central Government
• Determines National/regional
• Quota (# of shares to be issued);
• Allocates quota to regions

• 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)

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Quota Allocation (97-99) vs. Earlier Net Profits (94-96)

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