China's
securities experiment: the challenge of the globalization
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Note: Footnotes Omitted
Part
V. Analysis and Conclusion
As pointed out by the World Bank, a securities market can be very useful
to developing countries like China. In a free economy, it can effectively
allocate resources through competition driven by the supply
and demand of capital resources.
As the securities market develops and strengthens,
it can benefit other parts of financial sectors as well
as the wider economy.
However, if the mechanism of securities market is distorted,
it may not be so useful.
No country¡¯s securities market develops isolated from its external
environment ¨C the national and even international economy. In China, the core of development of the
securities markets is the reform of the State-owned enterprises
(SOEs) which so far remain pillar of China¡¯s national economy.,
and internationalization of China¡¯s securities are is also
closely related to this reform.
The SOEs are also of huge importance in China¡¯s
securities markets, because, as satirized by a Chinese scholar,
China is the only country in the world which has securities
markets where 95 percent of listed companies therein are
State-owned enterprise.
Therefore the sound performance of those SOEs is crucial
to the performance of the securities market itself.
In this section I will address the following matters concerning the
development of the securities market and its external environment,
and draw conclusions accordingly.
A.
Reforming SOEs through Transforming them into Stock
Companies: A dream? A Game?
To reform its cumbersome SOEs, China has tried several approaches.
In the early 1990s, concurrently with the drafting
and passage of the Corporation Law, the government launched
a new approach ¨C ¡°corporatization¡±. One aspect of this approach is to transform SOEs into Joint
Stock companies to be listed in stock exchanges. As a programmatic document of the Communist Party of China
(CPC) stated, ¡°The joint stock system is a form of capital
organization of modern enterprises, which is favorable for
separating ownership from management and raising the efficiency
of operation of enterprises and capital. ¡±
From the government¡¯s view, this approach present several
benefits.
First, it expands the fund-raising channel for SOEs. Second, SOEs can transform their operational mechanisms in
compliance with the requirements of modern enterprises. And third, it helps to allocate financial
resources to benefit SOEs.
These optimistic predictions, if not complete day dreams,
at least turn out to be one-side wishes in some sense.
The major problem is that, for many of those transformed joint stock
companies, if not most, their names fall short of the reality. They have merely the corporate structures
of western stock companies, but are still being run in the
old way of administrative control. For many SOEs, the main benefit from the
transformation into joint stock company, is not the opportunities
to ¡°restructure itself into a modern enterprises¡±, but
rather to raise capital to alleviate financial difficulties.
In order to obtain approval from the CSRC, they disclose
false figures of profits or even forge financial reports.
Therefore many SOEs, especially the relatively small ones,
are not reliable for investors.
Another significant problem is that, China¡¯s investors have little
sense of responsibility as shareholders.
Popular
interest in purchasing stock has been overwhelmingly motivated
by the prospect of rapid appreciation in market value, rather
than by long-term fundamental analysis.
It is a well-known fact that 99% of private investors
are oriented towards speculative profits. Investors rarely inquire into the stock
issuer's economic condition, operations, or future prospects,
apparently assuming that the government will not allow an
enterprise to fail. Dividends do not enter into the analysis.
Attention is directed solely to short-term fluctuations
in price. A report by Guangzhou East Market Research Firms indicated
that, in a poll about shareholders sense of Guangzhou, about
50.6% of those investors stated that they had little or
no knowledge of the operation of their companies. 43.7%
stated that they never had the sense of a shareholder.
The above-mentioned facts indicate that, partly,
the results of ¡°corporatization¡± are ironically beyond
the government¡¯s expectation.
B. Road Ahead: Relinquish
State Dominance and Government Control of Economy
So far the officially proclaimed guideline
of China¡¯ SOEs reform is ¡°separating
State ownership for corporate management¡±, with the intention
to preserve state dominance and government control in the
whole economic.
The government hopes to build a management team to operate
SOEs. According to the blueprint on SOEs reform
issued by the ruling party, the SOE managers should not
only be ideologically and politically qualified, law-abiding,
have a deep sense of responsibility, but also be familiar
with the business they engage in, be armed with modern knowledge
of business management and even finance, science and technology,
and laws. It seems
that they are seeking angels falling to the earth (specifically
China) from heaven.
However, in many cases the quality of the persons
they appointed fell far short. With the withdrawal of the State from
management of enterprises, the State supervision upon the
management withdraws as well.
Some managers have treated State assets like their
own private property. Corruption is thus produced. For instance, in the Shenzhen East Development Corp. case,
one manager embezzled about 17 million RMB through forged
sales contracts, then leave the company and disappeared.
In the Guangdong Huilai First Construction Ltd. case, the
general manager of the company repeatedly misappropriated
the funds of the company for seven years since 1987, and
he received no punishment until 1995.
The words of a local government official tell the truth
of the quality of some SOEs¡¯ management teams, ¡°[m]any
state factories have become an empire, with the general
manager as the emperor who is accountable to nobody.¡±
All these ridiculous but understandable problems
stem from one thing, the ambigutiy
of State-enterprise property relationship.
Clear ownership rights are fundamental to a society. It can provide important incentives to
use assets productively. As Demsetz stated, ¡°property rights
derive their significance from the fact that they help a
man form those expectations which he can reasonably hold
in dealing with others. Without those expectations, people
are unable to predict whether they will have a given set
of assets at their disposal and are thus less likely to
make the most efficient use of those assets. At a minimum,
then, a system must parcel out some (or most) of the constituent
rights of ownership into a bundle of rights which are clearly
defined and legally protected.¡± However, clear ownership by itself is
not enough. In
terms of ownership in an enterprise, an enterprise has what
are known as ¡°residual risk holders¡±. In order for these risk holders
to be willing to accept risk, they must (1) be compensated
for holding that risk by being the owner (and therefore
having control over the enterprise's operations and profit
and loss distribution) or (2) be able to escape the risk
by selling the right to hold it. If either of these two
conditions exists, the owners of the enterprise are likely
to behave efficiently.
Under Chinese definition of ownership rights of SOEs, the State legally
owns all the assets of SOEs, and SOE managers are entrusted
by the State to operate the enterprise.
One can reasonably conclude that this formula can never
achieve success. First, the managers have no or little
incentive to behave efficiently and to make profits for
the enterprise because under China¡¯s current employment
system a manager¡¯s compensation has nothing to do with
his performance in managing the company. Second, the managers have no or little responsibility for the
failure or loss of profit of the company because the current
system does not pursue a manager¡¯s personal liability in
case of failure of a company. The managers must be subject to effective
external supervisions.
In a free economy the shareholders are responsible
for selecting managers of a company and those managers are
accountable to them. This formula, however, does not currently
work in China, partly because the State is not equipped
to supervise the management of every company, and partly
because private shareholders otherwise than the State are
somehow consciously excluded from supervising management.
The key to solving this dilemma is to gradually privatize the SOEs
and relinquish government control over them. In a private ownership based society, the misappropriation
of corporate assets seldom happens, and the corporate managers
have both the financial and personal incentive to behave
efficiently to operate the corporate business.
The Chinese government and the ruling party CPC has
realized that the privatization approach might be their
last but nevertheless the best resort to solve the SOE problems.
On the 4th Plenum of the 15th
CPC Central Committee on September 22, 1999, the CPC issued
the Decisions on Major Issues Concerning the Reform and
Development of State-Owned Enterprise, which, though does
not appear the word ¡°privatization¡±, has implied the Party¡¯s
strong interest in this regard. According to the Decisions, 1) the
State will control only those industries relating to national
security, public utility and those industries that are naturally
monopolized, while withdrawing from other commercial industries;
2) the development of non-public ownership, such as private
business is strongly encouraged; 3)small and medium-sized
SOEs will be enlivened through merger, leasing, or sales
to private persons; and 4) failed SOEs must be diminished
through bankruptcy and closing.
Chinese economists predicated that in the long run the State
will definitely withdraw from 80 to 90 percent of the national
economy.
In Chinese leaders¡¯ eyes, the issuing of stocks is a good way to legally
and effectively restructure the SOEs and gradually transfer the SOEs to the control of shareholders.
With respect to this approach, the government must
permit State shares and Legal person shares to be tradable,
and allow non-state institutions to raise acquisition of
SOEs if they pay a good price.
It is believed that with more and more private joint
stock companies and transformed entering into the securities
market, the market will finally boom as expected by the
government.
C. Conclusion: Toward
A More Global Securities Market
Placing a sound and fast growing economy as the core for the realization
of its international strategy, China is determined to develop
a well-run capital market.
Recently, in response to the sluggish securities
market, Chinese securities authorities has taking gradual,
yet significant toward building a more global market. In my opinion, more bold reforms are still
needed in the following respect.
First of all, based on above analysis, one cannot escape to draw the
conclusion that the State dominance in the securities market
should be relinquished and government control should be
loosened. Currently stock shares are classified
by the identity of the shareholders and the shares holder
by the State or State owned companies are not on the market
and their transfer are absolutely restricted between State
agencies and State owned companies.
Thus, a majority of the shares issued are excluded from
the secondary market.
In order to enhance the liquidity of the securities
market and therefore increase the efficiency of resource
allocation, the government should let the State shares and
Legal Person Shares to be tradable in either stock exchanges
or OTC markets, opening the aforesaid shares to individual
holders. In addition, the government should avoid excessive administrative
control over joint stock companies and vigorously encourage
nonstate shareholders to exercise their rights.
Another significant reform expected should be the merger of A shares
and B shares market, thus eliminating the existing opportunities for arbitraging
between types, to the ultimate detriment of the Chinese
issuers. If the merger is done, it will then become
possible for both foreign and domestic investor to purchase
both kinds of shares.
It has been said that the merger of the two markets
will only take place when the capital account become convertible
and the RMB can be limitedly exchanged or purchased by foreigners.
This is not a big issue given the fact that China
has a huge international financial reserve,
only second to Japan.
For the merger Chinese regulators should not worry
too much, because China now is enthusiastic in attracting
foreign investment and foreign portfolio investment is only
another form of investment.
China
also should provide a more sustainable legal framework which
is largely deregulation-oriented.
The existing Securities Law is more restrictive than
necessary.
Moreover, transparency in the legal system is definitely
essential , not only to meet the WTO requirements, but also
to stimulate the creativity of market participants and eventually
to the healthy development of the securities market.
Considering its short period of re-emergence and regardless the present
problems, China¡¯s securities has been somewhat successful
in attracting capital and restructuring State owned enterprises. To achieve its goals of making its stock exchanges one of the
major international financial centers, China must take bold
steps toward internationalization and privation and to embrace
a mature and efficient regulatory system compatible with
major international market standards. If China does, it will present the world with a huge but attractive
securities market.
