Capital markets and legal development The Chinanext term case

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Capital markets and legal development:

The China case

Zhiwu CHEN

Department of Finance, Yale School of Management, 135 Prospect Street, New Haven, CT 06520, USA

Accepted 19 September 2003

Abstract

Recent research establishes a significant positive correlation between law and finance (and hence

economic growth), restarting a debate on the law matters thesis. However, which way the

causality goes is still not clear. The purpose of this paper is to use the ongoing reform experience of

China, especially its capital market experience, to examine the direction of causality. First, we show

that Chinas recent experience is largely consistent with Coffees [Yale Law Journal 111 (2001,October)] crash-then-law interpretation of this correlation. Indeed, it is the large and clearly

defined constituency of investors that has been a key driving force behind much of the recent legal

progress. The rights and economic interests of this constituency have fundamentally challenged the

traditional emphasis of the Chinese legal culture on administrative and criminal sanctions, but not on

civil litigation law. Second, we compare the different contributions to legal change made by the stock

market and the consumer product markets. We argue that capital markets are perhaps the most

conducive to the formation of a politically powerful constituency and hence more aggressive legal

change, because of (1) the higher degree of commonality among interested parties and (2)

immediately measurable and tangible damages. These two characteristics not only allow investors to

identify with each other more easily, but also create an ideal basis for more debate in the media,

which in turn promotes the development of a legal culture.D 2003 Elsevier Inc. All rights reserved.

Keywords: Law and finance; Legal reform; Shareholder rights; Product liability; Capital market development;

Economic development

1. Introduction

A central thesis in the law and economics literature is that law matters for economic and

market development. According to this thesis, the existence of a legal system that protects

1043-951X/$ - see front matterD 2003 Elsevier Inc. All rights reserved.

doi:10.1016/j.chieco.2003.09.016

E-mail address: [email protected] (Z. Chen).

China Economic Review 14 (2003) 451472


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to create constituencies that are the most effective in causing legal change? Clearly, the

answer will differ from country to country, depending on a countrys own preexisting

context. If there are general characteristics about the types of economic activity that are the

most conducive to legal change, understanding them will help shed new light on theinteractive dynamics between law and economic development.

The purpose of this paper is twofold. First, we show that Coffees (2001) crash-

then-law interpretation of both the abovementioned correlation (between law and

finance) and the capital market history in the United States and the United Kingdom

is largely consistent with the ongoing reform experience in China.3 For young markets,

it is economic development that precedes legal change, rather than the other way around.

Unlike Russia and other East European countries that took a shock-therapy approach to

economic transition, from 1978 onward China has adopted a gradual trial-and-error

approach to transform its planned economy into a market-oriented one, starting with the

agricultural sector. After its success with reforming the agricultural sector in the early

1980s, China began to restructure its state-owned industrial enterprises into joint-stock

corporations, and first opened the Shanghai Stock Exchange in December 1990 by

letting several former state-owned firms go public. While the Chinese stock market has

helped former state-owned enterprises (SOEs) raise capital from the public, its impact on

legal change has perhaps been even more significant. The experience is one of true

crash-then-law.

Second, we compare the different contributions to legal change made by the stock

market and the consumer product markets. In economic terms, the impact of Chinas stock

market on the real economy and society as a whole has been marginal, with about 10million investors, whereas the various consumer product markets have been large in a

country with more than 1.2 billion people. That is, while the stock market may have

directly affected only a small fraction of the population and a small percentage of Chinese

businesses, the consumer product markets have affected much larger proportions of the

population. Thus, the constituency of citizens arising from stock market development

should be much smaller in number than the constituencies arising from consumer product

markets. Yet, the former has been a much stronger force for legal change. Why is it so?

2. Chinas legal tradition

A distinctive feature of Chinas legal tradition is that the legal system is not separated

from, or independent of, the administrative system (e.g., Jones, 2003, for an excellent

overview). At least since the Tang dynasty (618906 A.D.) and until the end of Qing in

1911, the system of government in China consisted of a strong central government headed

by the Emperor, who ruled through a bureaucracy and with absolute power. The lowest

ranking officials at the county level represented the central government and in effect

exercised all of the power of the state, including tax collection, public works, and even

3 See Boycko, Shleifer, and Vishny (1997) for discussions on transition and legal adaptation experience

in Russia.

Z. Chen / China Economic Review 14 (2003) 451472 453


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deciding lawsuit cases. Thus, adjudication was simply one of the many administrative

duties. Since there was no doctrine of the separation of power among government

institutions, the county magistrates power was virtually unchecked except that the

subjects could technically appeal to a higher level official.Another distinctive feature is its emphasis on administrative and criminal sanctions,

with a lack of formal development in civil liability and procedural law. The traditional

Chinese view, even as of today, is that the law is an instrument used by the ruler to

enforce its power and authoritative control and to maintain social order. Consequently, as

the central part of the Qing Dynastys legal system, for example, the Qing Code was a

collection of rules that were predominantly concerned with the official activities and

functions of the bureaucrats within the government apparatus, not with disputes and

relationships between and among private citizens. The imperial law touched upon private

matters only as the matters were thought to affect imperial policies. Thus, the code was

primarily of an administrative nature, and it tended to rely only on administrative and

criminal penalties. This is in sharp contrast with the Roman law tradition, from which

western laws are derived. At the heart of Roman law is civil law, rather than

administrative law. Roman law arose during a time when Rome was a small agricultural

society. As a result, the law developed mostly in response to the occurrence of disputes

between private citizens and/or social groups. Therefore, early on, civil matters occupied

a central place in western laws. As Jones (2003) commented, In China, the subject

matter of Roman civil law was considered only when it affected the interests of the

Emperor (p. 13).

Todays legal system in China is not much changed from the dynastic era. The law isstill viewed as an instrument of the ruling class; The judicial system is still treated as part

of the governments administrative system and hence there is no effective judicial

independence; Politics and adjudication are often mixed together; There is still no

officially adopted doctrine of the separation of power. Todays legal system probably

differs from those in the different dynasties, mainly in that after the mid-1980s and as part

of the reform efforts, there have been many newly enacted substantive laws (particularly in

the areas of commercial and civil law) and even a Civil Procedure Law of 1991. That is,

there are many more laws on the books today than in the various dynasties. However, as

discussed later, the existence of these substantive and procedure laws has not fundamen-

tally altered or neutralized the two dominant characteristics of the legal system mentionedabove. Many judges are not trained lawyers, and even a large number of them, especially

in less developed provinces, are former military officers who had no formal legal training

prior to being a judge. Still, since 1978, a substantial legal framework has been put in

place, with institutions that together resemble a western legal infrastructure (except there is

a Communist Party politicallegal committee that is super-imposed on the legal system,

controlling the assignment, promotion, demotion, and replacement of judges). It is issues

and conflicts arising out of the economic reform process that have played the critical role

of pushing the legal infrastructure to work and adapt. The economic development process

has generated an increasingly larger force for judicial independence. The ongoing case of

China is a vivid example of how the crash-then-law process works. We next show that itis the stock market and private securities litigation that have been central in injecting life

into the laws on the books.

Z. Chen / China Economic Review 14 (2003) 451472454


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3. Stock market and legal development

Economic reform started in 1978, soon after the end of the disastrous Cultural

Revolution. However, until the mid 1980s the focus of the reform efforts was on theagricultural sector, allowing farmers to have a piece of land to grow grain crops and retain

whatever profits the farmer was able to generate. However, no one was given or allocated

the ownership of any land property, and the farmers were just given the usage right for a

short period of time (land usage right was reshuffled among villagers every few years).

The main objective was to encourage family-based farming and individual responsibility

(rather than collective farming as practiced before the reform started). There was then a

large increase in income and living standard among farmers.

The success in agriculture then started to affect the debate on how to reform the industrial

sector where state ownership was by far dominant. The first experiment in the mid 1980s was

to apply the individual-responsibility model of farming to industrial enterprises. That is, an

individual manager or a team of managers could assume the responsibility of an SOE for

several years, with an annual revenue or profit target. Profits above the target would be paid

to management and workers as bonus. This responsibility model did not work out, since it

promoted mostly short-term behavior by management. It was then realized that without

clearly defined ownership, there would not be an incentive structure to induce managers to

take a long-term view.4 In the late 1980s, therefore, joint-stock limited-liability corporations

became the new experiment, with some SOEs converted into joint-share corporations.

3.1. The stock market

Preparation was then also under way to start an official stock exchange to trade shares

of the new joint-stock companies. But, private ownership and privatization was political

taboo. In particular, no one would want to be responsible for causing the loss of state

assets. As a political compromise, the reformers proposed to have several classes of shares:

state shares, legal-person shares (only ownable by legal-person institutions and corpo-

rations), and floating common shares (A-shares for domestic citizens only and B-shares for

foreign investors only). In particular, the state shares and legal-person shares would not be

publicly tradable, so that no loss of state ownership would occur. However, regardless of

share type, the holder of a share is entitled to the same cashflow and voting rights. Today, atypical public corporation has about one third of its shares in each category of state, legal-

person, and floating common shares.5 Given that most legal-persons or corporations are

4 In some sense, state ownership represents an extreme form of diverse ownership as each citizen in the

country is supposed to own an equal piece of the firm. Thus, the separation between ownership and control is also

extreme. But, there has been no corporate governance structure in place to ensure the functioning of this extreme

separation. Since the state controls the management of each SOE and since the government is not democratically

elected, there is no institutional infrastructure to ensure that the agents at the various levels all work in the best

interest of the ultimate shareholdersthe citizens. Therefore, it is not surprising that the management

responsibility model did not work.5 See Chen and Xiong (2001) for a study on the underpricing structure of legal-person shares. They show that

because these shares are not tradable, they are priced at an average discount of 86% to the otherwise identical

floating common A-shares. This pricing and liquidity distortion is also a source for corporate governance problems.



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state-owned or state-controlled, about two thirds of most corporations shares are state-

controlled directly or indirectly. This ownership structure has been a major factor behind

the difficulties in private securities litigation, because granting damage awards in private

litigation would amount to the loss of state assets (to the extent that the state owns amajority of the shares outstanding), which puts the court in a conflicted situation.

Besides the state-dominated ownership structure, another obstacle blocking private

securities litigation is ideological. The traditional communist view was that only income

through labor is rightly acceptable. Though the Shanghai Stock Exchange opened in

December 1990 (followed by the Shenzhen Stock Exchange 2 months later), this official

line on rightful income remained in the Communist Party charter until November 2002,

when the 16th Party Congress changed the charter to officially acknowledge that

acceptable income can be earned through both labor and capital (i.e., monetary capital,

intellectual capital and managerial capital). Therefore, until late last year, Communist

Party members were officially not supposed to buy or trade stocks; otherwise, any income

from holding stocks would not be legitimate. This ideology was of course contrary to the

notion of shareholder rights and the protection thereof, which has been partly responsible

for the slow implementation of the Securities Law and the Company Law of the Peoples

Republic of China (PRC). It has been an obstacle between law on the books and law in

action. The question again is what led to the removal of this obstacle last year? How did

China eventually move the law off the books and into action, at least to some extent?

To answer these, we should keep in mind that the very justification for starting a stock

market in China was to help the SOEs raise capital from the general public and solve the

money-losing SOEs financial problems, and that it was not to offer the general public away to diversify investment portfolios and hedge future consumption/income risks.6 Thus,

shareholder rights were more of an afterthought, which became a concern several years

after stock trading became widespread. One practice that was followed from 1990 to 2000

was that the government adopted a quota system on the number of IPOs for each year, so

that there would be a planned and orderly sequence of IPOs with no supply shocks. This

idea and practice of a planned growth path have been so much at the heart of the Chinese

modernization process over the past 150 years that it is almost impossible to do away with

(e.g., Goetzmann & Koll, 2002; Kirby, 1995). Another consideration for the planning was

to make the IPO flow low enough, so that IPO prices would be high, creating an

impression of unbeatable IPO demand and setting a perfect environment for more SOEs toissue shares. In other words, the first task of the government agencies in charge was to

manage and maintain a positive and encouraging market.

At the beginning of each year, the national IPO quota was approximately equally

divided among the 32 provinces and province-level cities. Table 1 shows the number of

IPOs for each year to lie between 13 and 206, with an average of 100 new listed

companies per year. This implies that in a typical year, each province would get a quota of

about three IPOs. This limited supply of IPO permits clearly made the value of each such

permit very high, and created a huge opportunity for rent-seeking and bribing. Conse-

6 Walter and Howie (2003) argue extensively that the Chinese governments determined interest has really

been, and will continue to be, to use the equity capital markets as a tool of enterprise reform, while other by-

products of the capital markets have been more of a side purpose.



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quently, each provincial government set up a dedicated Securities Listing Office to both

lobby the China Securities Regulatory Commission (CSRC) for a higher quota and to

assist local firms to prepare for IPO.

For provincial and lower governments, the number of local firms they can have publicly

listed has become a major metric of performance, on which future promotion of local

government officials depends. As a result, provincial and lower level officials are all themore willing to help local firms manipulate financial numbers or commit unmasked fraud,

all for the purpose of getting more local stocks traded nationally. Or, when local firms are

caught by the media for committing financial fraud or earnings manipulation, local

governments and sometimes even higher government agencies would cover up the fraud.

Both the central governments bias in helping the SOEs and the local governments

desire for political performance have not helped to give much weight to shareholders

interest. From the very beginning, the PRC stock market was biased against shareholders.

Even after a company successfully obtained an IPO permit (usually as a result of much

lobbying and/or bribing efforts), the process of preparing and filing for IPO could easily

take more than 2 years (true even as of today). The first period in the long IPO process isthe so-called ShangShi FuDao Qi (the pre-IPO nurturing period). This nurturing

period is literally to strip a money-losing SOE into two pieces: the good piece (to be

IPOed) and the bad piece (to be the controlling shareholder after the IPO of the good

piece). This is sometimes the period of creating fake receipts and fake contracts to make up

whatever profits that are needed to meet the IPO requirements. For example, the PRC

Company Law requires a candidate IPO firm to have positive earnings in each of the most

recent 3 years. Additional CSRC regulations further require the firm to satisfy conditions

on return-on-equity (ROE), before an IPO approval can be granted. These requirements

have forced firms to manipulate earnings and financial results.

After an IPO, the firm again has to satisfy profitability requirements to issue seasonedequity offerings (SEO). For example, over the years, the minimum condition for an SEO

as set by CSRC regulations has gone through various changes: the firms ROE had to be

Table 1

IPO listings and capital raising on Chinas stock market

Number of new

listings in each year

Total amount raised

through IPO and SEO(million yuan)

1991 13 500

1992 40 9409

1993 124 31,454

1994 110 13,805

1995 24 11,886

1996 203 34,152

1997 206 93,382

1998 106 80,357

1999 98 89,739

2000 137 154,086

2001 79 118,214

2002 71 96,175

Data used in this table are graciously provided by www.SinoFin.com.cn.

http://%20http//www.SinoFin.com.cnhttp://%20http//www.SinoFin.com.cnhttp://%20http//www.SinoFin.com.cnhttp://%20http//www.SinoFin.com.cn


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(1) positive in the most recent 2 years, a policy as of 1993; (2) above 10% based on the

recent 3 years average, as of 1994; (3) above 10% in each of the recent 3 years, as of

1996; (4) above 10% based on the recent 3 years average, but at least 6% for each of the

recent 3 years, as of 1999; and (5) above 6% based on some weighted average for therecent 3 years, as of 2001. These four policy changes have each time c aused publicly

traded firms to adapt their accounting manipulation schemes. In one study, Lang and Wang

(2002) find that for each year before 1994, strangely many public firms had their ROE just

slightly above 0%; then, between 1994 and 1999, more than half of the public firms had an

ROE lying slightly above 10% but below 12%; but, from 2000 onward (in particular since

2001), most of the firms had an ROE between 6% and 8%. Their study presents perhaps

the strongest evidence of marketwide earnings manipulation, implying that investors have

been systematically defrauded.

Another common practice by Chinese public companies is tunneling, as defined in a

different context by Johnson, La Porta, Lopez de Silanes, and Shleifer (2000), that is,

controlling or majority shareholders engage in related party transactions with the listed

firm, usually with the latter buying worthless assets from the former at unreasonably high

prices or with the latter lending to the former at favorable rates. As the Chinese magazine

New Fortune has reported, tunneling of shareholder assets is widespread and has led to

calls for regulation and tighter enforcement by the CSRC.7

Given these systematic problems mentioned above, the Chinese stock market still

managed to become the third largest one in Asia based on market capitalization (after

Japan and Hong Kong). As of July 2003, the Shanghai Stock Exchange and the

Shenzhen Stock Exchange together have 1259 companies listed (A and B sharesincluded). The combined total market capitalization of the companies is over 4 trillion

yuan (about US$500 billion),8 and trading is active with a monthly turnover rate of

18.2%. About 20% of the 1259 companies are private firms, without the state being the

controlling shareholder.

By no means is Chinas stock market well developed yet. But it does show signs of life.

Table 1 shows the total amount of capital raised in each year. In Table 2, we see that the

amount of capital raised on Chinas stock market is, when measured as a fraction of GDP,

lower than the U.S. market but higher than Japans and Germanys, in the 1990s. It should

be recognized that this period marked the beginning of Chinas stock market (hence one

would expect some level of exuberance).The above brief review of the development background illustrates that in the 1990s and

even today there is not enough ideological acceptance of private ownership and stock

trading, neither is there sufficient protection of property rights. Especially in the early

7 See Clarke (2003, in press). Featured articles on corporate governance issues (in Chinese) can be found at

New Fortunes website: http://www.newfortune.net.cn.8 The exact market capitalization value for all listed companies combined is a mystery because the state and

legal-person shares are not publicly traded and hence no reliable price information can be used to value them. The

4 trillion yuan given here is based on the official estimate published on the CSRC w ebsite, in which they simply

multiply the total number of shares outstanding by the floating A-share price. From Chen and Xiong (2001), it is

clear that this is an over estimate of the true value, because the legal-person and state shares are sold in private

transfer and auction transactions, at an average discount of 86% relative to the floating A-shares. See also Walter

and Howie (2003) for another discussion on this market capitalization issue of Chinas listed firms.

http://%20http//www.newfortune.net.cnhttp://%20http//www.newfortune.net.cnhttp://%20http//www.newfortune.net.cnhttp://%20http//www.newfortune.net.cnhttp://%20http//www.newfortune.net.cn


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years, China did not have a legal infrastructure to support capital market development.

However, consistent with the crash-then-law hypothesis of Coffee (2001), China started

out without a clear idea of what institutional framework would be needed for a stock

market, but as investors increased in number, a powerful constituency was developing,

which led to a sequence of legal development.9

3.2. The years prior to the securities law of 1999

Chinas stock market was started top-down, with the CSRC and other government

agencies controlling every step of the way in both the overall market development and the

process of a firms pre-IPO preparation as well as post-IPO operations. The stock

exchanges are state-owned and managed by government-appointed officials, while the

securities firms are state-owned (or majority-controlled) either directly or indirectly. Since

the beginning of the market, it has been a well known secret that every public company

had been nurtured financially and repackaged just for the sake of IPO, with widespread practice of making up the numbers so as to meet the listing requirements.

Even with so much known accounting fraud and open market manipulation, private

securities litigation did not arise in significance until 2001 after a sequence of events.

Though the Shanghai Stock Exchange started in late 1990, suing management and

directors and/or other parties for damages was not much on investors mind until after a

sustained market downturn started in the middle of 1993. As Fig. 1 shows, over the first

year and a half, the Shanghai Stock Exchange Composite Index (hereafter SSE Compos-

ite) went straight up from 100 in 1990 to 1266 by May 21, 1992. In particular, the index

9 See Hutchens (in press) for an excellent account and analysis of the development history of private

securities litigation in China. He summarizes the various factors (positive and negative) that have each contributed

to legal development in a country whose tradition has deemphasized civil law.

Table 2

Raising capital through the stock market across countries (%)

China United States Japan Germany France

1991 0.02 0.231992 0.36 0.90 0.06

1993 0.91 1.64 0.16 0.11

1994 0.30 1.64 0.08 0.03 0.18

1995 0.20 1.08 0.20 0.27 0.29

1996 0.50 1.26 0.54 0.56 1.94

1997 1.25 1.72 0.27 0.29 0.08

1998 1.02 2.35 0.74 2.74 0.88

1999 1.09 1.34 0.93 1.04 0.85

2000 1.72 2.03 0.90 1.44 1.44

2001 1.20 2.33 0.49 0.29 1.56

2002 0.94 1.26 0.34 0.20 0.85

Average 0.79 1.60 0.47 0.61 0.90

S.D. 0.65 0.25 0.13 0.02 0.47

The total amount of capital raised includes both IPO and seasoned equity offerings on the stock market. The ratio

reported here is the total capital raised divided by the countrys GDP in the same year.



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went from 617 to 1266 in a single day on May 21, 1992. It was then followed by 5 months

of decline. But, that decline did not last long enough to get a substantial number of

investors to call for private litigation against corporate manipulators. In late 1992, the

government stepped into encourage stock trading, restarting an upward movement.

In the early 1990s, even if any investor had wanted to sue for damages, the court would

not have accepted such lawsuits. The only law that shareholders would be able to rely onup until July 1, 1994, was the PRC General Principles of Civil Law, which provides that

victims of torts are entitled to civil compensation. However, the PRC judiciary had little

experience with tort law in general and securities law in particular, which remains true

today. Legal training was all but stopped during the Cultural Revolution, and then restarted

around 1980.

Furthermore, the legal system is modeled after the Japanese civil law system, which

in turn was adapted from German law during the Meiji reform period of the 19th

century. An overwhelming theme of Chinese law is that wei jin pizhun bu ke, that is,

without a formal written rule from the law or from a legal interpretation by the Supreme

Peoples Court (SPC), judges cannot on their own interpret and apply a legal principle todecide specific cases. Given that at the time when the PRC General Principles of Civil

Law was enacted in 1986 there was not a stock market, it is not surprising that the

general PRC Civil Law did not include securities-related provisions until revisions in the

late 1990s.

In principle, before judges can accept any new type of private suit, in general the

National Peoples Congress has to first pass a law for the specific area and then the SPC

has to issue one or more detailed legal interpretations. This process can last for 5 years

or longer.

Nonetheless, while there was no securities law until July 1, 1999, administrative

regulations were introduced to fill in the gap. The Provisional Rules on Stock Issuance andTrading of 1993 issued by the CSRC proscribed various miscreant practices and provided

for civil compensation for those who were financially injured as a result (Hutchens, in

Fig. 1. History of Shanghai Stock Exchange composite index.



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press). But, the court was not ready for private securities litigation, and hence these

administrative provisions would not amount to anything for private investors. Penalties

based on the Provisional Rules of 1993 could only be enforced either administratively by

the CSRC, or through criminal litigation by the Public Security Department. The followingare three representative cases of this nature:10

1. The first administrative case on insider trading was announced on January 28, 1994, in

which the violator, the Shanghai securities brokerage division of the XiangFan Trust

and Investment Company (a subsidiary of the Agricultural Bank of China), was fined

by the CSRC. The violator was accused of (1) insider trading and market manipulation

and (2) trading stocks using customer account capital. The brokerage division was

ordered to turn in all the trading profits of 16,711,808 yuan (about US$2 million), and

pay a fine of 2 million yuan (about US$240,000). The brokerage firm was also

suspended from trading for 2 months. But, in this case, no manager or any other

individual was personally fined or penalized in any way. Still, this case marked the first

attempt to enforce rules on the stock market.

2. The first administrative case against false disclosure and misleading statements in

connection with securities trading was decided on June 7, 1996. In this case, the named

violators were the DaMing Group (a listed company of ShengLi YouTian), and the

underwriter firm, accounting and auditing firm, and law firm that each provided service

to facilitate the IPO of the DaMing Group. The CSRCs charge included

misrepresentation of the listed companys outstanding share structure, omitting material

facts, and false statements in its IPO Prospectus. The administrative penalty included afine of 2 million yuan for the listed company and a warning to its board of directors.

The named underwriter firm, accounting firm and law firm were respectively fined

400,000, 200,000, and 100,000 yuan. Again, no individual manager or other person

was fined or named in the administrative action.

3. In December 1999, the Prosecutory Office of Chengdu City formerly filed a criminal

action against the chairman and key executives of HongGuang Enterprise (a listed

company) for accounting fraud. On November 26, 1998, the company was fined, while

its directors and executives were warned, in an administrative action by the CSRC. The

company was found to have overstated its 1996 and 1997 earnings, respectively, by 157

million and 31.52 million yuan. On December 14, 2000, the court ruled against thedefendants in the criminal case.

These and other administrative and criminal sanctions were taking place at an

accelerated pace after 1995. It was happening against the following background. When

the Shanghai Stock Exchange opened in December 1990, there were 45,000 individual

stock accounts and most of the investors were Shanghai locals. As the stock market went

unstoppably higher in 1991 and 1992, the easy money generated much excitement and

10 For details of these and other administrative cases, visit the CSRC website: http://www.csrc.gov.cn. Under

the leadership of CSRC Chairman ZHOU Xiaochuan, particular efforts were made to improve market and

administrative transparency. Part of the efforts was to make the CSRC website more informative and accessible to

the public.

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attracted more and more individuals into the market. Hertz (1998) gives a sociological

account of the China stock-trading phenomenon. Occasional encouraging and possibly

misleading editorials by the Peoples Daily (the central governments mouthpiece) and

remarks by top leaders have also played a significant role in mobilizing the public to buystocks, which tends to serve the governments purpose of helping the financially distressed

SOEs well.

By the end of 1999, there were 44 million stock accounts (this number went up to over

70 million by April 2003).11 As noted above, the wave of administrative actions against

violators of securities rules started in early 1996, which coincided with the last phase of the

3-year long bear market that began in mid-1993. During this unprecedented, long bear

market, many individual investors were stuck with losses, and these losses motivated them

to seek ways of recovery. The investors were joined by professional and academic

commentators to call for better enforcement of market rules and ultimately for a better

market. This wave of public pressure then forced the CSRC to take more aggressive

administrative actions in 1996 and onward. Thus, it is the first bear market, together with

the fast-growing investor constituency, that led to significant public enforcement (crash

then administrative enforcement).

However, from the administrative penalties, the public learned that first of all, managers

and intermediaries responsible for misleading or cheating investors were actually not fined

personally (but only given a verbal warning). It is usually the listed companies that were

fined. That is, the shareholders, not the responsible violators, ultimately were paying the

fines. Secondly, shareholders who suffered losses were not given any piece of the

administrative fines (the fines went to the Ministry of Treasury). Thirdly, as in the latersecurities criminal cases, defendants may have been jailed, but that again did not help

injured investors recover any financial loss.

Unable to benefit from administrative or criminal sanctions, investors and the more

general public all learned about the limitations of the traditional emphasis on administra-

tive and criminal penalties by the Chinese legal system. In a major sense, investors care

more about recovering loss than about whether a violator is fined administratively or

jailed. Thus, the public debate on private securities litigation started to gain momentum.

Fortunately, in a country with a generally restricted press, the financial media (including

print, Internet, and TV) has enjoyed increasingly more freedom, so investors, professio-

nals, and academics can openly discuss shareholder rights and civil litigation issues. Thecommon economic interest led to the informal formation of a significant constituency,

though for political reasons the government forbids any formal shareholder organization.

The Company Law of 1994 does provide ambiguous support for certain shareholder

rights, including the right to seek compensation for damages due to financial fraud,

misleading statements, market manipulation, and so on. But for the reasons mentioned

11 The number of investors is vastly different from the number of stock accounts. First, the same investor has

to have one account with the Shanghai Stock Exchange and one with the Shenzhen Stock Exchange, if he or she

is to trade stocks listed on both exchanges. These two accounts of the same investor are counted as two, implying

the70 million accounts must be divided at least by two. Second, investors often own multiple accounts to hide

their identity by opening accounts using borrowed ID cards from others. This is a common practice especially

among market manipulators, who have to hide their trades to evade regulators attention. Some believe a realistic

number of investors is more like 10 million or less. See Walter and Howie (2003) for more discussion.



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above (e.g., the lack of operational guidance or legal interpretation from the SPC), the

court refused to accept private securities litigation until years later.

In April 1999, a shareholder in Shanghai filed a civil suit against HongGuang

Enterprise for financial damages due to the defendants accounting fraud (see thedescription of the first criminal case discussed above). But, for many months, the Shanghai

court gave no answer as to whether the case would be accepted. Then, in early 2000, the

court decided not to take the case.

3.3. Where is the crash?

On December 29, 1998, the National Peoples Congress passed the PRC Securities Law

and the Law became effective on July 1, 1999. Together with the Company Law of 1994,

this marked the completion of the laws on the books concerning corporation formation,

public offering, and securities trading in China. However, this does not mean that injured

investors could rush to court to file lawsuits for damage recovery or to force a

corporations board and/or management to take shareholder-interest-maximizing measures.

The PRC Securities Law became effective in the midst of a stock-market bull run that

started in January 1999 and ended in June 2001 (when the SSE Composite Index reached a

peak of 2218). During that period, accounting fraud, market manipulation, and insider

trading were rampant. The CSRC took 92 administrative actions against perpetrators

(including 104 corporate entities and 270 individuals).12 The media also reported on fraud

cases. But, the bull market made the new formal law almost unnoticed for 2 years (most

investors were probably busy counting profits).Within the first 2 years after the PRC Securities Law became effective, investors made

few attempts (if any) to seek damage recovery through litigation, and the judiciary was not

in any hurry to prepare for the enforcement of the Securities Law. The Supreme Peoples

Court was not working to draft a legal interpretation or procedural rules for the new law.

When many investors were profiting from the bull run and only some investors were

suffering losses from fraud, the pressure for fast legal change could not be too high. There

had to be a crash (or a sustained period of decline).

Then, several key events occurred. On April 23, 2001, the CSRC announced a major

administrative penalty against four fund management firms in GuangDong, fining them a

total of 400 million yuan (about US$50 million) in addition to ordering them to return thesame amount of illegal profits. The cause for action was that from October 1998 to

February 2001, the four firms engaged in manipulating the stock price of, and publishing

false statements concerning, Yorkpoint Science & Technology. The chairman of York-

point, his relatives, and key managers were all behind the manipulation scheme and held

stakes in the defendant firms.13

In the July 2001 issue, Caijingmagazines cover story featured a detailed account of the

fraud scheme of Yorkpoints stock. In the immediate August issue, Caijing published an

extensive investigative report on another high-profile corporation, YinGuangXia Enter-

12 Visit the CSRC website for data on administrative actions: http://www.csrc.gov.cn.13 The fines are yet to be collected. Judicial decisions in civil cases and administrative fines are often hard to

enforce, another reality in China that is waiting for reform.

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prise.14 It was found that from 1998 to 2001, YinGuangXia fabricated sales receipts (with

hundreds of millions worth of exports to Germany) and lied to the market about various

production facilities that actually never existed. The total amount of faked sales was over 1

billion yuan (about US$120 million), which resulted in a nonexistent profit of 770 millionyuan. This scandal was a shock not only to the investor community but also the larger

society in general. Many expected to see accounting fraud of a lesser nature, but not so

egregious. The YinGuangXia scandal was dubbed the Enron of China. These stories

came out just as the stock market was suffering a major downturn from the June high of

2218 for the SSE Composite Index to around 1700 by the end of September (see Fig. 1).

These events provided the needed crash for legal change. Disappointed investors started

to demonstrate in front of the CSRC building. Key officials from the CSRC initiated

meetings with the Supreme Peoples Court, urging the court to assume a more significant

role in regulating securities markets through adjudicating cases. However, a typical

Chinese official (whether in a bureaucratic position or in a judicial position) always

thinks in terms of administrative territories. In this case, matters related to stock trading

were considered to be the sole responsibility of the CSRC, not that of the judicial system.

Thus, even after the CSRCs efforts to convince the court of its role, the judiciary showed

much reluctance to join in.15

On September 20, 2001, investors filed suits against the company and management of

Yorkpoint Science & Technology, simultaneously in the No. 1 Intermediate Court of

Beijing, the Intermediate Court of Guangzhou, and the Intermediate Court of Shanghai.

Some investors in Jiangsu province were preparing to do so as well. Lawyers were also

filing paperwork in different courts to sue the management, and directors of YinGuangXiaEnterprise, and other responsible parties.

In the mean time, newspapers and TV were full of stories of angry investors, with

articles detailing legal rules and remedies concerning securities litigation. A wave of

lawsuits was in formation, which challenged the Supreme Peoples Court and the entire

PRC judicial system. To the Communist Party, this appeared to be too dangerous politically.

3.4. The temporary ban on private securities litigation

On September 21, 2001, the Supreme Peoples Court issued a notice directing all lower

courts temporarily NOT to accept private securities lawsuits. Just as a private litigationstorm was about to begin, such an announcement was a shock to everyone with a stake in

the market or concerned about capital markets and legal development in China. It

prompted an immediate outcry from various professions and interest groups. It fueled

much further heated debate not just on market development, but also the rule of law in

general and judicial roles in particular. That notice put the Supreme Peoples Court on the

spotlight. In retrospect, private securities litigation had provided Chinas court system with

14 See Caijings website for current and past articles: www.caijing.com.cn.15 Private conversations with participants in these discussions between the CSRC and the Supreme Peoples

Court suggest that senior officials from the Court were blaming the CSRC for all the securities trading related

troubles and that the judiciary did not want to get involved. Protection of shareholder rights was not exactly the

first thing on the Courts priority list.

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the best chance to gain political standing and respect in the larger Chinese society. But the

highest court squandered the chance.

From several interviews given by the then Vice President of the Supreme Peoples

Court, Mr. LI Guoguang, it became clear that the Court had the following concerns. First,as suits were filed against the same defendants and for the same cause but by different

plaintiffs and in different lower courts, it became possible that there would be different

rulings, the occurrence of which would jeopardize the reputation and credibility of the

legal system. In the history of the PRC, there had never been such an instance in which

numerous plaintiffs would simultaneously file separate lawsuits in different provinces but

against the same defendants and for the exact same cause. How should the court system

respond to this possible crisis? Could there be chaos, both legal and political? Second, if

financially injured investors would each file an individual suit, the entire court system

would be more than overwhelmed with securities litigation. Are there efficient ways to

handle such mass litigation? Third, given the lack of prior experience in this area, the

lower court judges had no uniform standards yet with regard to who has a standing to sue,

what type of evidence is required, how damages are calculated, and so on. Finally, if there

would be numerous lawsuits against all these listed firms and if the private plaintiffs would

be awarded rightfully deserved relieves, it would lead to major losses of state assets (since

the listed companies are mostly state-controlled). In such civil litigation, the defendants

interest is in fact the states interest. This is precisely where plaintiffs rights and state

interest collide. Is there a compromise between the two? How can there be judicial

independence? These questions and reasons were sufficient to cause the Court to pause.

The extensive debate and analyses by legal experts in the mass media following thenotice served as one of the best legal education opportunities for the public. It was during

this period that even individuals with no legal training learned about what class action

litigation means, why class action may be the best mechanism for securities litigation,16

why there should be more emphasis on civil liability than administrative or criminal

liability, who should bear the burden of proof in securities litigation, why the court should

accept private action suits, and so on. As a result, a large number of investors and readers

can now comment on class action and the burden of proof. Observing these

developments from a crash-then-law perspective, one can see how a legal culture is

developed in such a process.

3.5. Partially lifting the ban

On January 15, 2002, the Supreme Peoples Court issued a second notice dictating that

lower courts may accept private securities litigation based on false disclosure and material

misrepresentation, subject to the condition that administrative penalty has been imposed

on the alleged fraud. However, the ban remains in place for private litigation based on

other types of claim, such as insider trading and market manipulation.

While the second notice did open the door for private securities litigation in a limited

way, the required precondition of an existing enabling government action was troubling

16 Chen (2002) provides a detailed argument for class action litigation in China, and a review of the U.S.

experience in securities class action litigation.



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and led to a new round of debate (hence, a new opportunity to develop the legal culture).

The requirement was against the principle of judicial independence, which the PRC

Constitution guarantees, and it substantially compromised shareholder rights. It was also a

fundamental rewrite of the PRC Securities Law. The Supreme Peoples Courts justifica-tion was that the lower courts have no prior evidence-discovery experience related to

securities litigation and that the precondition is a transitional convenience.

Nonetheless, within a week and on January 24, three investors went ahead to file

separate suits in Harbin against DaQing LianYi, a listed company, and its management for

false disclosure and accounting fraud. Soon afterwards, 767 other investors sued the same

defendants for the same claim. Since class action litigation is forbidden by the second

notice, these separate cases had to be resolved individually.17 The Intermediate Court of

Harbin conducted individual case hearings for 2 months from August to October 2002, but

managed to go through only 94 out of the 770 suits.

In 2002, nine other listed companies and their respective management members,

directors, and other responsible parties were sued in nine different courts. Among them,

YinGuangXia was named as a defendant in 1100 individual suits, again all for the same

cause of accounting fraud.

After the lower courts accepted this wave of lawsuits and in some cases held court

hearings in 2002, none of the cases has yet been resolved by a judicial decision even to the

date of this writing (several have been settled outside of court). The reason this time was

again that more detailed procedural and substantive rules are needed concerning who has

the standing to sue, how damages are to be determined (e.g., adjusting for systematic risk

or not), and so on.This led to the issuance of the PRC Private Securities Litigation Rules (hereafter, PSL

Rules) by the Supreme Peoples Court on January 9, 2003. The PSL Rules is the most

detailed legal interpretation yet of the PRC Securities Law (with 37 articles), and it is a

result of extensive consultation with legal and finance experts and scholars. This new

interpretation still limits private securities litigation to false disclosure causes (no private

action is accepted on insider trading or market manipulation grounds), and it still requires

enabling government action as a precondition for the court to accept a private suit, except

that now the condition can be met by either an administrative penalty or a criminal court

ruling. New restrictions are added as well. Among other things, Article 9 states that all PSL

lawsuits must be filed with the intermediate court of the jurisdiction in which the listed firmis headquartered. The official justification for this rule is judicial convenience (e.g., easier

for evidence investigation). This restriction is inconsistent with the PRC Civil Litigation

Procedure Law, which gives the plaintiff a choice of jurisdiction between the plaintiffs

local court and the defendants. As noted earlier, local governments have a strong incentive

17 The lawyer, Mr. GUO Feng, representing 696 shareholders against DaQing LianYi was insisting on group

litigation for his clients, not individual litigation. His negotiation with the Intermediate Court of Harbin lasted for

almost the entire year 2002, with the stand that he would not give in unless the court accepted group litigation. His

insistence and continuing efforts between the Harbin Intermediate Court and the Supreme Peoples Court played a

crucial role in moving private securities litigation forward. As Hutchens (in press) observes, entrepreneural

lawyers have made a significant contribution in Chinese legal reform. While Mr. GUO insisted on group

litigation, lawyers representing the other 94 plaintiffs agreed to individual litigation, which is why the Harbin

court held hearings from August to October 2002.



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to protect listed companies from their jurisdiction, implying lower courts will be biased to

favor local defendants. Thus, this restriction comes at the expense of shareholder rights and

in favor of fraudulent listed firms. It also exposes another characteristic of the PRC legal

system: judicial convenience takes precedence over plaintiff rights.Overall, the new rules provide lower courts with specific operational instructions for

handling false disclosure claims.18 The PSL Rules generated new excitement early this

year, and made disappointed investors more hopeful of a loss recovery. But, so far, no

court ruling has been decided on any of the 2000 or so pending cases, an indication

perhaps of the lower courts waiting for further clarification and instructions from the

Supreme Peoples Court on certain unclear rules.

It has been more than 4 years since the PRC Securities Law became effective. While

much progress has been made, Chinas judicial system is still struggling with the

implementation details. The distance between the law on the books and the law in

practice is thus not short.19 This is particularly true in countries that follow the continental

civil-law tradition of top-down law making. The PRC experience further proves the

advantage of common-law systems in which judges at all levels are given substantial law-

making power.

4. Private product liability litigation

In contrast, private litigation in the area of consumer product liability has not been at

the forefront of legal change in recent years. Several laws and judicial interpretation formthe formal basis for civil litigation on product liability:

1. The PRC General Principles of Civil Law of 1986 provides for civil compensation for

damages due to product defects (Articles 122, 130, 131, 132, and 136).

2. The judicial interpretation notice issued by the Supreme Peoples Court on January 26,

1988, outlines operational details for lower courts to adjudicate private product-

liability suits.

3. The PRC Civil Litigation Procedure Law of 1991 gives further procedural details

(Article 72).

4. The PRC Product Quality Law of 1993 and the PRC Consumer Rights Protection Lawof 1993 are the principal area laws concerning product liability.

The two area laws passed in 1993 were largely in response to rampant selling of

defective, fake and counterfeiting consumer products in the late 1980s and early 1990s.

However, that legislative response fell into the rule by law category, as they have

become more of a rule book for administrative and criminal sanctions. The private

18 See Hutchens (in press) for an in-depth overview and analysis of the PSL Rules and its impact on

securities litigation and legal institutions in China.19 Pistor (2000) argues, based on a sample of transitional economies, that transplanting laws from another

country usually does not succeed. A countrys preexisting institutional infrastructure may need to change

substantially for a transplanted substantive law to work.



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litigation experience based on the product liability laws has been quite limited. Compared

to private securities litigation, which has made much progress in the last 2 years, private

litigation on product liability still lacks momentum.

The PRC government has a quality inspection and control department or center for eachtype of consumer product, such as Computer Quality Inspection Center, and Pharmaceu-

tical Product Quality and Regulatory Agency. These administrative departments and

agencies have served as the primary public enforcer of the PRC Product Quality Law.

They often run political-movement-like campaigns to crack down on defective, poor-

quality, and counterfeiting products, by confiscating and burning them. The first of such a

campaign was launched by the State Council in 1992. Over the next 10 years, the total

amount of confiscated products was worth over 30 billion yuan.

From www.Lawyee.com, one of the largest legal case databases in China, the earliest

private product-liability case that we can find took place in 1989, in which a community

department store (GongXiao She) in Baotou City of Inner Mongolia sued a refrigerator

supplier in the same city. The cause for action was that when an employee at the

plainstiffs store opened a refrigerator sold by the defendant in 1988, the employee was

electrified through the refrigerator handle and killed. The refrigerator was then inspected

and found to be defective by the Citys Product Standards Bureau. The local court then

found the defendant to be liable and ordered the latter to (i) refund the 7900 yuan purchase

price, (ii) pay a total of 13,987 yuan (about US$1500) for the surviving dependents of the

killed employee, and (iii) pay for other losses and expenses of 5400 yuan.

There have been other sporadic private litigation cases based on product defects, but

most of them have not attracted much attention. From www.Lawyee.com, we were able tocollect 80 private product-liability cases (43 of them were consumer-product cases, 7 cases

involved a product that caused death, and 32 cases involved bodily damage to product

users). Out of this sample, 59 cases ended with the plaintiff winning. The largest damage

award granted by the judge was 1.08 million yuan (about US$130,000), and the average

damage award was 127,395 yuan (US$15,000). The damage awards typically included

three components: compensation for direct damage, punitive damage, and litigation

expenses incurred to the plaintiff. These damage awards are clearly nowhere comparable

to those typically awarded for product liability in U.S. courts.

Among the few cases that have received much media attention are the multiple lawsuits

against Toshiba, a Japanese multinational firm. In October 1999, Toshiba accepted aUS$2.1 billion settlement in a class action filed against Toshiba (U.S.A.) in a Texas district

court.20 The complaint was that even after NEC announced and advertised a defect in its

floppy disk microcontroller back in 1989, Toshiba knowingly continued to use it in its

laptop product line. The defective disk drive caused data loss for two users. The plaintiff

class included half a million impacted users. After this settlement in the United States,

Toshiba never informed any of its customers of this defect in China and it continued to sell

computers with this defect there.

On May 8, 2000, someone in China accidentally learned about the 7-month-old Toshiba

settlement on the Internet and published a story in Chinese, which prompted an angry

reaction from numerous consumers. Internet message boards and print media were full of

20 See Robertson (1999) for a report on this settlement.

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nationalistic and emotional comments. A stage was set for active debate among legal and

law experts. On May 25, the first joint action against Toshiba was filed in Beijing by nine

Toshiba users.21 On August 15, three individuals filed another suit against Toshiba in

Shanghai. No news about the outcome of these suits is known even today, perhaps becausethat debate had too much nationalistic flavor and the government had to keep the court

ruling quiet.

To show how little progress has been made on consumer rights in China, note a famous

1999 libel case, Hengsheng Computer v. Wang Hong et al. In August 1997, Mr. WANG

Hong bought a laptop computer made by Hengsheng Computer, and later found the laptop

to keep shutting off on a regular basis. Within the warranty period and on June 1, 1998,

Mr. Wang took the laptop back to the computer store where he made the purchase. But, he

was denied any service. After several failed attempts and in late June, Mr. Wang decided to

post an angry comment on an Internet bulletin board, and filed a complaint with the

government-sponsored Consumer Rights Association of Beijing. No progress was made in

obtaining repair service after almost 2 months. Next, Mr. Wang posted more comments on

the Internet. Two newspapers, Microcomputer World Weekly and Life Time, reported on

this story, respectively, on August 10 and July 27.

In April 1999, Hengsheng Computer filed a lawsuit against Mr. WANG Hong and the

two newspapers for libel damage. The lower court ruled that the defendants were liable for

injuring the plaintiffs reputation, and ordered Mr. Wang to pay damages of 0.5 million

yuan (US$52,000, 25 times Mr. Wangs annual income) and each of the two newspapers to

pay 0.25 million yuan to the plaintiff. Upon appeal, in December 2000, the Beijing No. 2

Intermediate Court reduced the damage award against Mr. Wang to 90,000 yuan (about 4.5times his annual income).

The courts decisions in that libel case illustrate just how far the legal culture for

consumer rights has to go. Mr. Wang was trying to get a promised warranty service. His

Internet postings were an effort to call upon other consumers to boycott the manufacturers

products. Yet, for doing that, he is still paying for the libel judgment.

5. Comparing product-liability and securities litigation

An intriguing research question is: Why has private securities litigation led to muchlegal development whereas product-liability issues have not? What characteristics distin-

guish the two areas? In real impact terms, the stock market affects a relatively small

fraction of the population (10 million in a 1.2 billion population), while consumer products

touch upon the daily lives of the entire society. Thus, consumer rights should be relatively

more important to both the economy and society. But, as hypothesized in this paper, the

stock market has been more powerful when it comes to the ability to drive legal change.

21 Note that in consumer product-liability litigation, plaintiffs could use the joint-action litigation device in

May 2000, whereas even today the Supreme Peoples Court does not allow for this device in private securities

litigation. In product-liability litigation, the likelihood of a major domestic political crisis is considered low. In

contrast, the PRC government has been much more concerned about the political risk prospects of allowing class

action suits in securities litigation. See Lawrence (2002).



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We can speculate to offer the following points. First, commonality is what characterizes

the investor constituency. In securities fraud, all affected shareholders are injured by the

common fraudulent act, at the same time and in the same location. Damage causality is

easy to establish, especially since there is typically no role played by the shareholders incausing the damages. In contrast, there are diverse types of consumer products. Even with

respect to the same product type, say, Toshiba computers, damages to users may occur at

different times and in different locations. This fact alone creates a weaker sense of

commonality among injured consumers. While it is sometimes technically possible to trace

all the damages back to the same defect, a defense often used by producers and distributors

is that the consumer did not use the product properly and that it was the consumers fault.

Product-liability cases require plaintiff-specific proof of causality.

Second, damages are easily and immediately measurable in securities trading. To

measure stock investment losses, you do not require additional information beyond price

declines. Furthermore, financial loss is the only type of damage to be concerned within

securities cases. In contrast, damages to consumers due to product defects are often hard to

measure and intangible. Such damages can be as grave as death, and they can also be quite

subjective and difficult to measure financially. This measurement difficulty and the

intangibility of damages make the formation of constituency much harder to achieve.

Finally, these two characteristicscommonality and immediate measurability of loss

also render securities litigation and shareholder rights an ideal topic for the media to report

and debate on. The daily realization of stock trading gains and losses is a feature that is

largely responsible for making the stock market a persistently popular topic at social

occasions and other places. In contrast, not many consumer products (if any) are perpetually popular topics. Thus, the medias attention on stock market trading is also a

major factor in the easier formation of a politically powerful investor constituency.

6. Conclusions

The debate on whether law matters for economic and market development has been

going on for decades, especially since the work by Max Weber and Friedrich von Hayek.

In recent years, commentators have pointed to Chinas recent growth experience,

especially in comparison with India, which has a far better institutional infrastructure, tosuggest that law does not matter for growth and market development.22 These comments

are implicitly based on the law-then-growth thesis. However, a closer look at the PRC

experience shows that for young markets, it is probably more like crash-then-law or

growth-then-law, a thesis argued by Coffee (2001). The initial phase of development (in

both the economy and markets) is necessary both for a constituency to be formed and to

set the stage for crashes or problems. Legal change will then follow. Legal reform is

necessary in the second phase to prepare a country for further, more mature economic

growth. Thus, a legal order may not be a precondition for initial market development, but a

precondition for more mature development.

22 See Thakur (2003) for a growth comparison between India and China, and Kristof (2003) for a comparison

between Russia, Ukraine, and China.



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Bear markets are often necessary for legal change, as happened in the United States in

the early 1930s. Each of the two major downturns of Chinas stock market (1993 to 1996

and 2001 to the present, as shown in Fig. 1) led to a significant change. The first downturn

generated pressure for the CSRC to take more aggressive administrative actions againstviolators, while the second set the stage to push for private securities litigation.

Another lesson from the PRC experience is that different types of economic activity

present different pressure levels for legal change. Capital markets are perhaps the most

conducive to the formation of a politically powerful constituency and hence dramatic legal

change, because of (1) the higher degree of commonality among interested parties and (2)

immediately measurable and tangible damages. These two characteristics of capital

markets not only allow investors to identify with each other more easily, but also create

an ideal basis for more debate in the public media and other places, which in turn promotes

the development of a legal culture. Anecdotal evidence indicates that there is probably

more media coverage of legal issues in China today than in other countries. Private

securities litigation has challenged the traditional Chinese view that law is a tool used by

the ruling class to rule. It has also challenged the traditional focus on substantive law rather

than procedural law.

Acknowledgements

The Author would like to thank the editor for this issue, Belton Fleisher, for his

patience and encouragement, Donald Clarke, Andrei Schleifer, and Steve Yun for theircomments and suggestions, and SHI Minglei, WANG Yonghua, XIONG Peng, Steve Yun,

and ZHOU Feng for helping with the date and case collection. Any remaining errors are

the authors responsibility alone.

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Capital markets and legal development The Chinanext term case

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