Reforming the capital market

China Forum

New guideline stresses the market's role in listings and delistings and is expected to smooth out financing and equity incentives

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 Friday. 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 in a dire recession for years and hopes were high that the authorities would act and make changes.

The country's 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 voices 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.