Friday, February 29, 2008

Stop, Or I'll Criticize!

From the Economist:

When China's two stock exchanges were created in 1990, the chief goal was to use private savings to restructure state-owned firms. Investors received only minority stakes and limited sway over corporate governance. Equally important, both exchanges were run by bureaucrats, so there were fewer incentives to increase their value by attracting companies and punters. There was little effective competition between them.

Over the past 18 years, China has introduced rules against market manipulation, fraud and insider dealing, but enforcement remains patchy. The China Securities Regulatory Commission seems competent but overwhelmed. Sometimes it takes years to issue penalties after lengthy investigations—and along the way cases lose relevance.

In the meantime, the exchanges have quietly begun to acquire authority. The power that they wield appears flimsy—the most serious penalty they can levy is a rebuke to firms and individuals through public notices. But it is remarkably effective in a country with a long history of punishment by humiliation—think of the cangue, a rectangular slab around the neck, in pre-Communist times and dunce caps in the Cultural Revolution.

Messrs Liebman and Milhaupt write that between 2001 and 2006 the exchanges publicly criticised 205 companies and almost 1,700 people. They looked at the share prices of the targeted firms both when they disclosed the conduct for which they were being criticised and when the criticism was published. The admissions typically preceded the rebukes, and in the few weeks that followed the firms' share prices underperformed the Shanghai stockmarket by an average of up to 6% (see left-hand chart). After the criticism, there was a further lag of up to 3% on average (see right-hand chart).

(Nod to Neanderbill)

1 comment:

Anonymous said...

Professor Liebman and Milhaupt will publish a paper on reputation sanction in Chinese securities market (also see a brief intro from Economist) with the finding that there is a significant effect of such sanction. These reputation sanctions are given by Shanghai and Shenzhen Stock Exchange. Given the ineffectiveness of legal sanction in China, they further suggest that it is quite conceivable that the exchanges may become better regulators than the official ones.


(pic from Economist intro)

This suggestion is along the line of pro-deregulation through promoting self-regulation as an alternative. Much research on self-regulation has been done by some US scholars with the case study of NYSE. NYSE was funded on May 17, 1792, when the Buttonwood Agreement was signed by 24 stock brokers outside of 68 Wall Street in New York. On March 8, 1817, the organization drafted a constitution and renamed itself the “New York Stock & Exchange Board,” which was shortened to its current name in 1863. John Coffee, a prominent corporate law professor, argues that it was NYSE’s regulation of security market, rather than legal or administrative regulation, lead to a large and liquid securities markets. Since NYSE is an association of brokers, the nature its regulation is deemed as private, or self-regulation, as contrasted to the governmental regulation through federal securities laws and SEC rules. Self-regulation is proved in NYSE case to be superior to the governmental regulation.

Liebman and Milhaupt surely do not simply assimilate China’s Shanghai and Shenzhen Security Exchange to NYSE. The Chinese security exchanges are facing rather different situations from NYSE did. What makes Shanghai and Shenzhen Security Market better than their judicial and administrative peers is that the security exchanges are less submissive to the “rival interests and institutional capacity.” And it is for this reason, Liebman and Milhaupt argue, that Chinese Security Regulation Commission–roughly Chinese counterpart of SEC in the US–was willing to delegate its authority to Shanghai and Shenzhen Security Exchange. And since the two exchanges are doing well, Liebman and Milhaupt seem to see it as another triumph of a pro-deregulation thought: the private authority, or at least semi-private, beats the governmental authority.

This sounds like a cheerful conclusion. It releases some anxiety people have when investment is in an unknown market, it satisfies the curiosity on what kind of rules a market without legal rules would follow, and most importantly, it helps settle the puzzle why a non-rule-of-law regime can support such long-term economic growth. Nevertheless, the conclusion is built on sand.