In just over 2 decades China has developed a stock market that is now one of the biggest in the world. This is puzzling, considering that law in general and investor protection in particular in China is widely regarded as weak. However, a thorough examination reveals that, far from being a counterexample, the case of China lends strong support to the “law matters”’ thesis. Granted, investor protection counted for little during the rapid growth of the market before mid-2001. But by the early 2000s, outrageous securities frauds had become endemic, bringing the market to a serious crisis. Faced with a constituency of angry investors and the prospect that the market might collapse, the government was forced to crack down on frauds and strengthen investor protection. It was only after frauds had been considerably curbed and a degree of order established that the market recovered in 2006 and experienced an enormous boom in 2007. Nevertheless, since August 2009 the market has run into another prolonged bear and crisis. This time the principal cause is low corporate profitability, which has roots in both weak investor protection, in the forms of managerial corruption, waste and mismanagement, and defects in areas not related to investor protection.
The experience of China indicates that a precondition for a stock market to emerge and grow is a demand for and enough supply of capital in the economy. It demonstrates the critical role of investor protection in sustaining market growth and attests the sequence of growth first, followed by law. However, such a virtuous circle of “growth-law-further growth” is not a guarantee. While securities frauds have been greatly curtailed in China, managerial misconduct has not. Fundamentally, political and economic reasons explain why market growth has led to improvement of investor protection in one area but not in another. The facts that market growth preceded law and that it was political and economic factors that drove or hindered investor protection improvement in China seem to contradict the proposition that legal origins determine the strength of investor protection. Moreover, China’s experience indicates that the scope of investor protection assessment undertaken by “law and finance” research and certain international organizations is too narrow to capture China’s improvement in the area of securities frauds. Furthermore, a stock market’s growth capacity is ultimately determined by its performance in investment return and investor protection is only one factor that affects that performance. An obsession with investor protection and law may risk that other important issues are neglected.
Looking ahead, while securities frauds would no longer seem to be a serious threat, the Chinese stock market still faces a serious challenge of how to increase corporate profitability, which will not only need enhanced investor protection but also changes in other areas. The difficulties the stock market faces are also facing the whole economy, and whether they can be overcome determines not only the future of the stock market, but also China’s whole economic development.
Available at: http://works.bepress.com/zhong_zhang/1/