1.1 The Puzzles
This chapter provides the motivations and objectives of the book. It identifies three core characteristics, corresponding to as many chapters, and presents the rationale behind their interconnections. The three core characteristics are: the domination of the market by China’s government and administrative apparatus; the inherent speculative character of the market; and the wide departure from the standard template of stock-market organization and functioning.
The main message here is that government involvement is key to an understanding of the, often surprising, characteristics of the market. We will argue that the strategy used by the government to build the stock market has been based on the need to gradually set up the increasingly complex financing channels of a growing emerging economy; an economy initially dominated by state-owned enterprises (SOEs), which was subsequently marketized and liberalized. Such a strategy was constrained by the persistent willingness to keep these processes under tight control.
As a by-product of its design this market is inherently speculative in character. This is reflected in recurrent bubbles, mostly separated by bearish episodes. A similar degree of government involvement is apparent in its stop-and-go policies which aim both at using the market and trying to tame it.
The departures from the features of a ‘complete’ market are so numerous that it is doubtful that the latter has been used as a template by the Chinese authorities. Investors have no true ownership of the companies they hold shares in. As a result, they are not involved, let alone interested, in governance. Moreover, since for many years the distribution of dividends was at best erratic and at worst nonexistent, the holding of shares by many (especially retail) investors has had by nature a speculative character, relying almost exclusively on expected capital gains. The published earnings have no clear relationship with stock prices since they do not reflect the profitability of firms.
Western scholars often benchmark the features of China’s stock market against global standards. The researcher’s attention thus always tends to focus on what the Chinese market lacks, rather than on how it is designed and actually functions. A full understanding of the Chinese stock market requires an analysis of the market on its own terms rather than by reference to a misleading benchmark (Li and Milhaupt 2013).
1.2 The Phoenix Market
We will look at the historical experience of China with stock markets over the last century and a half in Chap. 2. In a Phoenix-like fashion the stock market in Shanghai disappeared and reappeared several times. It is essential to look back to the immediate and remote ancestors of the modern Chinese stock market to grasp its specific features.
To understand the origins of the organization of companies in China, it is necessary to go back even further in time and review the forms of companies that emerged in imperial China in the late Ming dynasty, which ruled until 1644. Unlike Western companies, early Chinese business organizations were based on lineages and rules. Such lineage relationships lasted much longer than any form of business partnership and reflected collective ownership at multiple levels. This arrangement played a big role in the creation of some early forms of Chinese joint stock companies.
Although the central government of imperial China centralized power, the use of the market to provide financing for industrial/commercial enterprises was not its concern. However, Chinese entrepreneurs could still use an organizational structure similar to that of western companies and securities transactions to finance enterprises. The salt field in Zigong, in Sichuan province (Zelin 2005) and the Shandong Agricultural Company (Pomeranz 1997) were good examples of such a use.
The first Chinese stock market, in the late nineteenth century, was segmented between domestic and foreign participants, both for firms in the listing process and for investors. Listing was Treaty-port driven, which means heavily dominated by foreign firms, and investors were mainly China-based foreign residents.
The incompleteness of the market as well as its speculative nature, core features of the modern market, were already inherent characteristics of the Shanghai stock market during the 1865 to 1911 period. Government involvement was not a major feature initially under the late Qing dynasty but certainly played an increasing role, especially in the subsequent republican period.
A striking feature of the Shanghai stock market is its resilience, that is, its ability to often disappear and reappear, in a different shape, some time later. The longest period of extinction was experienced in the first four decades of the PRC, but this had been preceded by shorter interruptions in the first half of the twentieth century. In 1914 the new Republic of China issued the Security Exchange Law. In 1916 in Shanghai, Sun Yat-sen set up the Shanghai Stocks and Commodities Exchange and tried to fund the government by issuing bonds. The government of Yuan Shikai, in North China, set up its own Beijing Stock Exchange. In 1920 only Shanghai’s stock market remained in operation. Later on, Chiang Kai-chek closed the exchange which the Japanese had created in the early 1940s and, in September 1946, his government set up a new Shanghai Stock Exchange, which would be closed by the PRC.
Recurring speculative episodes were followed by equally large crashes, which dampened investors’ appetite for shares for decades, and this in turn was followed by a persistently depressed market. Dividend distribution was rather strange: it had no direct relationship with earnings but was regular and based on some magic fixed numbers. Accordingly, shares were often akin to bonds.
Government intervention took different forms during the period of the late Qing dynasty on the one hand and in the Republican period on the other. In the former period, companies were initially founded through the ‘government-controlled and merchant-managed’ scheme, though private ones appeared in the late 1890s; post-1911 government intervention was at times heavy.
In the PRC, as a by-product of the economic reforms of ...