The Information Challenge and a Market Solution to Legal Development – A Case Study of Overseas IPOs of China’s State Owned Enterprises

Abstract:     
We view a given legal institution in a given country as a network with potential positive network externalities in the sense that the more people use it, the better the system becomes, which attracts yet more users. The level of the positive externalities is largely determined by the information stock and decisional competence of the staff operating such institutions. Different levels of positive network externalities lead to fiercer institutional competition among different parts of a given legal system, such as the competition within one country between courts and regulatory agencies and between courts and arbitration tribunals. In an era of global economic integration, the competition could also go beyond national boundaries and occur between the same type of legal institutions in different jurisdictions, such as the competition between the securities regulatory framework in Mainland China and that in Hong Kong. When the domestic legal systems lag, market players sought solutions overseas, which in turn affect the domestic legal systems. This is exactly what happened during China’s stunning economic development against the rather lagged development of the legal system. In particular, the initial public offering of securities (the IPOs) by China’s state owned enterprises (SOEs) in overseas market, especially in Hong Kong, provides an example to illustrate the existence of such competition and the market oriented solution to the lag between legal development and commercial needs for compatible legal institutions. Such a consumption of foreign legal system does not end there. Instead, through transacting with pure domestic entities and interacting with domestic regulators, these overseas-listed Chinese SOEs in turn affected the development path of China’s legal system in the next return. This paper documented such a process and contributes to the understanding of issues, such as how China’s economic development is achieved in a legal system lagged behind and how human capital is accumulated and developed among players in the legal system to allow evolution of domestic legal system through a market-driven and market-oriented path as opposed to actions taken by the government. Such an exercise could also shed light on two other types of issues. The first type relates to institutional choice in help developing legal systems that facilitate and are compatible to market transactions. The second type relates to identifying market oriented solutions for problems that are traditionally addressed by non-market institution.

The paper is divided into four sections. Section 1 presents the framework for informational compatibility of the legal system and the market. Section 2 explains the particular challenges that China faces in building and operating a legal system that has the informational compatibility necessary for the transition from a central planning economy to a market economy. In Section 3, we look into the institutional details of how the SOEs completed their IPOs in overseas market when China’s own legal system was not ready for such sophisticated, complicated yet necessary market transactions. Section 4 analyses the impact of such an arrangement on the market and the legal system in China and its future development. Using this case study of overseas of IPOs of China’s SOEs, we identified a market oriented avenue for the evolution of domestic legal system, which serves an alternative to formal legal system that is created by the state government. Implication of legal development for other developing countries is also briefly addressed. Section 5 provides a brief conclusion.

Number of Pages in PDF File: 27

Keywords: China legal development, state owned enterprises, market solutions, network externalities, overseas IPOs

JEL Classification: K00, K20, K40, N25,P31, O16, O53, D83, F02, G15

working papers series