New lease of life for ailing capital market

Equity incentive mechanisms will be an effective step to address such malpractices

In a move to create a more transparent and multilayer capital market and promote its healthy development, the State Council promulgated a guideline detailing an array of capital market reforms on May 9. The guideline, called the "New Nine State Regulations" to differentiate it from the one published 10 years ago, has drawn wide attention from the market, given that it has come at a time when China's stock market has been languishing and hopes were high that the authorities would act and make changes.

The benchmark Shanghai Composite Index rose from 1,000 in June 2005 to 6,124 in October 2007, after the release of the old guideline in January 2004. But since then China's stock market has been stuck in a bearish state and failed to go up despite the series of policies and measures the authorities have adopted over the past seven years. Under these circumstances, there have long been market anticipations for a top-level policy design from decision-makers to reverse the gloomy capital market trend.

The promulgation of the new guideline also came as China is striving to open up its tightly controlled financial sector amid its economic slowdown, and it has thus sparked fresh expectations that economic development will be bolstered through some substantial reforms aimed at rejuvenating China's lackluster capital market.

Compared with previous government documents, the guideline encourages listed companies to set up a market value management system, the first stipulation of its kind in a State Council document, and urges them to improve their equity incentive mechanism and allow their shares to be held by employees in various forms.

Different from those in the West, China's stock market has a heavy State-controlled equity structure, in which directors of a majority of listed companies with State holdings are not allowed to hold shares and their chairpersons are usually appointed by the government rather than chosen by shareholders. As a result, what their management personnel most care about is how to retain their positions instead of how to maximize the company's profits. Under such an equity model, ordinary shareholders have no say in decision-making.

The establishment of market value management and equity incentive mechanisms will be an effective step toward addressing such malpractices. Only when top management personnel really care about the prices of shares, can they possibly steer the development of their companies in a direction that accords with the interests of ordinary shareholders.

The guideline vows to continue pushing ahead with a registration-based IPO system that stresses accurate and timely information disclosure by public companies, and developing a multilayered equity market with a more complete share transfer system for small and medium-sized enterprises.

A system for local governments to issue bonds directly will also be set up. Currently, local governments cannot directly sell bonds or borrow from banks, and can only seek financing via special vehicles such as urban investment companies, a model that is widely seen as one of the main culprits for the country's mounting local government debt.

In a move to curb risks, the document promises to lift the scale of direct financing. Statistics show that direct financing only accounted for 42.3 percent of the country's total financing volume by the end of 2012, much lower than the 87.2 percent in the United States and 74.4 percent in Japan, and even far behind the 66.7 percent in India and 66.3 percent in Indonesia. An imbalanced direct and indirect financing structure has caused a high concentration of China's financial risks in the banking sector and increased the difficulty and the cost of seeking capital to develop the real economy.

At the same time, the new guideline vows to set up a marketized and diversified delisting regime that conforms to China's concrete conditions and helps protect the interests of investors, and work hard for its strict implementation.

A delisting and accountability mechanism was also contained in the old guideline, but such a stipulation has not been really implemented. That is because many listed companies suffering losses were allowed to be listed due to historical factors and there are concerns that their forced delisting may cause strong discontent among ordinary shareholders.

Compared with the old one, the delisting mechanism promised by the new guideline is more operable, given that it targets new companies. A forced exit will produce strong deterrence to candidates harboring an intention to get listed through financial fraud or other malpractices and will effectively boost the credibility of China's capital market.

The promulgation of the latest guideline, which is mainly aimed at addressing some deep-rooted problems and malpractices underlying China's stock market recession, such as its unreasonable financing structure and the high leverage issue among domestic enterprises, is expected to have far-reaching influence on the country's capital market.

The author is a researcher with the Institute of Finance and Banking, Chinese Academy of Social Sciences. The views do not necessarily reflect those of China Daily.

(China Daily Africa Weekly 05/16/2014 page13)