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The Political Economy of an Incomplete Market

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Demystifying China’s Stock Market

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Abstract

The apparent convergence of the legal framework to international standards may hide major specificities of China’s stock market. In spite of the official progress made in creating rules and regulations, the practice of corporate governance is hampered because they are not properly enforced. The multiplicity of principals at work in the pre- and post-initial public offering process reflects core features of the organization of China’s state-owned enterprise sector and institutional apparatus. We will analyze these features using a political economy perspective.

The incompleteness of the Chinese stock market is the natural product of government dominance. The Chinese government did not intend to build a complete stock market providing signals for an efficient allocation of capital. The government has always intended to use the stock market as an economic instrument, and to try to keep everything under control. The government does not want the market to provide signals for the allocation of capital because it feels able to provide better signals than those provided by the market. The stock market in China is a politico-economic instrument, not a standard market.

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Notes

  1. 1.

    China’s stock market is often cited as a counterexample to the significance of law for financial development. The trajectory of development in China is growth first followed by law, and the improvement of law is caused by market growth. The experience of China suggests that law and market growth exhibit a bi-directional rather than a uni-directional causal relationship, and the course of development is “growth-law-further growth” (Zhang 2016). See also Chen (2003).

  2. 2.

    A survey and evaluation of corporate governance is provided by Weian and Chen (2015).

  3. 3.

    The scope and nature of decision making inside SOEs was regulated by an important document released in July 2010 (China Institute 2018) about TCOI (Three Critical and One Important Collective Decision-Making Policy) for decisions of four types: politically oriented situations; second mid- or senior-level appointments; corporate expansion or restructuring; and fourth the use of off-budget funds. The party committee should be consulted on any TCOI decision.

  4. 4.

    The presence of an internal capital market within a group is more frequent among local, rather than central, SOEs, and among state-owned, rather than private firms in China (He et al. 2013). Comparative evidence for 90 countries including China is provided by Gugler et al. (2012).

  5. 5.

    The negative effects of ownership concentration on firm performance in China are documented by Hu et al. (2010). For publicly-traded firms in China, ownership concentration seems to be the major factor behind profitability and efficiency (Guthrie et al. 2007). This result is valid even when controlling for dominant ownership type. The rise in ownership concentration associated with the rise of SASAC positively affected the performance of SOEs under its control (Wang et al. 2011).

  6. 6.

    Deconcentration and inter-jurisdiction competition is a factor put forward by Xu (2011) as one of the drivers of rapid growth in China in the 1980s and 1990s.

  7. 7.

    For earlier evidence on the link between accounting information and firms’ stock returns, see Chen et al. (2001).

  8. 8.
    $$ E/A=a+b{\left(M/A\right)}_{-1}+c{\left(E/A\right)}_{-1} $$
    (5.1)

    where E, A, and M, respectively, refer to earnings, the book value of assets, and market value.

  9. 9.

    We will not dwell here on the fact that this specification may be questionable from an econometric point of view. First, in terms of time series modelling, it leaves aside common factors across firms (a la Market model) and does not deal with the likely non-stationarity of the data. Second, due to many missing variables (such as changes in economic growth), it is very likely that coefficient b is overestimated. In contrast, market value should be filtered from factors which are unlikely to be linked to future earnings. The latter would raise coefficient b.

  10. 10.

    The literature on IPO underpricing in China is surveyed for 63 studies by Azevedo et al. (2018). The evolution of IPO procedures and pricing is reviewed by Su and Yu (2015).

  11. 11.

    SASAC attempts to harvest dividends from the companies under its remit are well tracked by Naughton (2008).

  12. 12.

    Deconcentration refers to the dispersion of control within one single organization, while decentralization refers to the transfer of control from one organization to another (Lemieux 2008; Aritonang 2016). This can be linked to the distinction made by Gu Yanwu between Junxian and Fengjian in his 1660 essay on the prefectural system (see Kuhn 1975).

  13. 13.

    Conflicts of objectives in state enterprise reform in China are well analyzed by Naughton (2017).

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Authors and Affiliations

  1. Aix-Marseille University, Marseille, France

    Eric Girardin & Zhenya Liu

  2. Renmin University of China, Beijing, China

    Zhenya Liu

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  1. Eric Girardin
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Girardin, E., Liu, Z. (2019). The Political Economy of an Incomplete Market. In: Demystifying China’s Stock Market. Palgrave Pivot, Cham. https://doi.org/10.1007/978-3-030-17123-0_5

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  • DOI: https://doi.org/10.1007/978-3-030-17123-0_5

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