What Does History Tell Us? The Roots of China’s Modern Stock Market

Abstract

An understanding of many, somewhat surprising, features of China's modern stock market and company organization requires a deep historical perspective on traditions dating back to imperial China. We will look at the form in which the corporation arose early on in imperial China in order to identify examples of well-functioning shareholding enterprises, understand the specific nature of contracting relationships, and explore the antecedents of sophisticated financial markets. After its emergence in the late 1860s, China's first stock market developed its own specific features which are still relevant, sometimes in a mirrored way, for China's modern stock market. Domestic issuers and investors were not treated on equal terms with foreign ones. The market was characterized by durable speculative or bearish episodes badly damaging the trust of investors. During the post-1911 period, bearish phases were frequent and the government was quite often involved, in particular, to set up or discontinue exchanges. In the wake of the deep reforms of the late 1970s and early 1980s, the re-emergence of share issuance and trading was active, rather spontaneous and somewhat hectic. It initially corresponded with the decentralized nature of industrial expansion during that period which took the form of a shareholding cooperative system for collective and small state-owned enterprises. There was no formal exchange but unregulated private placements. The landmark industrial reforms of the mid 1980s gave a decisive impetus to the restructuring of some enterprises into shareholding companies. There were some unregulated exchanges in large cities but transactions were mainly over-the-counter in a myriad of localities, leading to a highly speculative market. The design of China's modern stock market deliberately or unconsciously built on lessons drawn from the first Chinese stock market in three dimensions. First, the speculative character is a common feature, with the domination of individual investors for whom fundamentals do not play a major role. Second, the use of capital markets to provide financing to the government and state-controlled firms is shared between the old and the new markets. Third, incompleteness of the market is still present but for opposite reasons; it is a market dominated by domestic issuers and investors as opposed to earlier foreign dominance.