China’s reform process, stock market development, and testable hypotheses

Part of the Contributions to Economics book series (CE)


Milton Friedman states in the 2002 preface of his classic “Capitalism and Freedom” that “there is no doubt that the residents of China are freer and more prosperous than they were under Mao — freer in every dimension except the political”.16 This statement rests on the fact that China is uniformly ruled by the Communist Party of China (CPC). Nevertheless, to fully understand the factors that shape economic policy-making in China, the incentives and constraints among the interest groups within China’s political structure need to be considered. In general, opposition has taken place within a three-level state structure: The senior leadership, central government leaders and local government leaders.17


Stock Market Corporate Governance Firm Performance Initial Public Offering Legal Person 
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  1. 16.
    Friedman (2002, p. ix).Google Scholar
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    For details regarding the organizational structure of the CPC, see Shambaugh (2000, pp. 168–173) and regarding the structure of power within the CPC, see Lieberthal and Oksenberg (1990, pp. 135–168).Google Scholar
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    Cited after Prasad (2004, p. 2).Google Scholar
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    The following section on the current structure of the Chinese economy is derived from an OECD survey of China’s business sector and a World Bank survey on China’s ownership transformation. See OECD (2005a, pp. 81 and 135) and Garnaut et al. (2005, pp. 7–8).Google Scholar
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    Value added is defined as gross output minus intermediate consumption and equals the sum of employee compensation, net operating surplus and depreciation of capital assets. Firms are separated by the type of controlling shareholder. Private sector includes both domestic and overseas private firms and investment. The public sector includes state controlled (directly or indirectly) and collectively controlled enterprises. The non-farm business sector excludes agriculture, government and non-profit service sectors. It was equivalent to 76 per cent of GDP in 1998 and 79 per cent in 2003. See OECD (2005a, pp. 81 and 135).Google Scholar
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    Total number of national enterprises covers all state-owned industrial enterprises and enterprises with annual sales of over RMB5million. Return on assets is calculated as operating surplus divided by fixed assets plus inventories. Unless stated otherwise, reported data is for October 2004. See Garnaut et al. (2005, p. 7).Google Scholar
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    Total factor productivity of directly controlled state firms is less than half that of privately controlled firms based on OECD (2005a, pp. 97–98) estimates using comprehensive industrial micro data.Google Scholar
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    The inter-provincial divergence of GDP per capita has risen dramatically. Most central and western provinces have lost substantially in comparison to 1980. In Gansu province, for instance, per capita income fell from 84% of national average in 1980 to 56% in 1999. See Taube and Ögütcü (2002, p. 3).Google Scholar
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    A-shares are the most actively traded shares in China; see Shirai (2004, p. 1470) for details.Google Scholar
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    B-shares are held by foreign individuals and institutions and since March 2001 by domestic individuals in China. H-and N-shares refer to listings in Hong Kong and New York, respectively. Other overseas shares include “red chips”. This term refers to Hong Kong registered holding companies into which Chinese assets have been injected; see Wang, Xu, and Zhu (2004, pp. 470–474). See Appendix A.1: List of share categories of China’s stock market, p. 105.Google Scholar
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    According to OECD (2005b, p. 316) this framework is oriented towards protecting investors from ‚fake ‘acquisitions since some deals are aimed at manipulating market prices.Google Scholar
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    According to the guidelines, an individual must meet the following conditions to be considered independent. First, neither the individual nor his or her relatives may work for the listed firm or its subsidiaries. Second, the individual may not directly or indirectly own more than 1 per cent of the listed firm. Third, neither the individual nor his or her relatives may be among the largest 10 shareholders of the listed firm. Fourth, neither the individual nor his or her relatives may work for a company that owns more than 5 per cent of the stock of the listed firm. Fifth, neither the individual nor his or her relatives may work for one of the largest 5 shareholder companies; see World Bank (2002, pp. 83–99).Google Scholar
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    Jensen (1988, p. 23) views the market for corporate control as a major component of the managerial labour market in which alternative management teams compete for the right to manage corporate resources. Scharfstein (1988, p. 185) interpretes the takeover mechanism as an indirect means for shareholders to renegotiate their contract with management.Google Scholar
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    This includes essentially price liberalizations and the removal of entry barriers; see Guo and Yao (2005, p. 216).Google Scholar

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