Enforceability and the Effectiveness of Laws and Regulations

51 Pages Posted: 9 Oct 2017 Last revised: 14 Oct 2017

See all articles by Ke Li

Ke Li

Shanghai Stock Exchange

Lei Lu

Asper School of Business, University of Manitoba

Jun Qian

Fanhai International School of Finance, Fudan University; University of Pennsylvania - Wharton Financial Institutions Center

Julie Zhu

Fanhai International School of Finance(FISF), Fudan University

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2017

Abstract

Tunneling by corporate insiders poses a threat to the Chinese stock market. Controlling shareholders can divert assets from listed firms or coerce firms to serve as guarantors on questionable loans. A new rule, enacted in 2005, prohibits asset diversion for 'non-operational' purposes, and firms complying with this rule experience a reduction in related party transactions, an increase in investment and dividends, and better performance. Another contemporary rule, aimed to standardize practice of firms providing loan guarantees, has very little impact on firms. We attribute the differences in the design, implementation and effectiveness of the rules to different enforcement cost of the two types of tunneling activities. Relative to loan guarantees, it is much easier for a third party to determine (ex ante) whether a particular form of diversion destroys firm value, and recognize and verify (ex post) the losses to the firm resulted from the diversion. Our results highlight the importance of enforceability: laws and regulations that can be enforced at lower costs are more likely to succeed, especially in countries with underdeveloped formal institutions.

Keywords: Enforceability, controlling shareholder, tunneling, loan guarantee, asset diversion

JEL Classification: G30, G34, K42

Suggested Citation

Li, Ke and Lu, Lei and Qian, Jun and Zhu, Julie, Enforceability and the Effectiveness of Laws and Regulations (October 1, 2017). Available at SSRN: https://ssrn.com/abstract=3049233 or http://dx.doi.org/10.2139/ssrn.3049233

Ke Li

Shanghai Stock Exchange ( email )

Shanghai 200120
China

Lei Lu

Asper School of Business, University of Manitoba ( email )

181 Freedman Crescent
Winnipeg, Manitoba R3T 5V4
Canada

Jun Qian

Fanhai International School of Finance, Fudan University ( email )

Shanghai
China
86-21-63895501 (Phone)
86-21-62934572 (Fax)

HOME PAGE: http://www.fisf.fudan.edu.cn/show-65-69.html

University of Pennsylvania - Wharton Financial Institutions Center

2306 Steinberg Hall-Dietrich Hall
Philadelphia, PA 19104
United States

HOME PAGE: http://fic.wharton.upenn.edu/fic/

Julie Zhu (Contact Author)

Fanhai International School of Finance(FISF), Fudan University ( email )

220 Handan Road
Shanghai, 200433
China

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