Capital Market Theory and Operations

Author: He Xiaofeng
Publisher:
Publish Date: 2006-02-01
Features: In the field of economic science, finance is undoubtedly a prominent goldmine, and investment banking, which primarily studies the operation of capital markets, is the most dazzling gem among them. However, this discipline has only been introduced into China for about ten years, and its glamorous appearance and complex have yet to be fully understood. It remains a subject for scholars to continuously explore. As an emerging discipline, investment banking theoretically studies fields such as investment, corporate finance, capital market theory, financial intermediary theory, financial development theory, public policy theory, and financial engineering theory. In terms of practice, it examines the issuance and trading of securities, mergers and acquisitions, trust funds, asset management, financial derivatives, asset securitization, and financial advisory services. Methodologically, investment banking employs various complex tools such as econometrics and statistical analysis, economic and financial analysis, and comparative analysis. It can be said that investment banking is a typical field of knowledge that highly integrates innovation and practicality, harmoniously unifying professionalism and diversity.
Looking back at the 15-year development of China's capital market, it has followed an incremental reform model. What does "incrementalism" mean? There are many descriptions and summaries in the public. In my view, it is a process of alternating between balanced and unbalanced interest structures. That is, when dissatisfaction with the existing interest structure arises, certain "innovations" in the capital market are introduced, leading to the formation of a new interest structure. The new beneficiaries naturally seek to protect this structure, thus maintaining a period of stability. However, as this structure evolves, contradictions and changes arise, temporarily balanced frameworks gradually give rise to more unbalanced factors, and the new structure is eventually broken by increasing dissatisfaction, leading to further capital market innovations to form a new interest structure. This incrementalism is a "spiral upward" development, a dialectical relationship of "negation of the negation" in philosophy. Without being immersed in it, one cannot fully appreciate its essence; yet being trapped in it, one often fails to recognize its nature. How can this be demonstrated? The most typical example is the securities issuance market. Several years ago, I proposed the "IPO Paradox," a summary of the self-contradictory and seemingly paradoxical phenomena in the stock issuance market. For truly outstanding enterprises in certain regions of China to seek an IPO, they face two major hurdles: the government approval process and the market test. Often, after passing the first hurdle, the "timing" for the second hurdle—the "heavenly conditions, geographical advantages, and human harmony"—is lost. Only about 1% of enterprises that pass both hurdles may succeed. It is truly a case of "one general's fame is built on ten thousand bones drying."
Let's discuss the first hurdle: the government approval process. A truly outstanding local enterprise faces three major obstacles: the first is the various institutions of the central government; the second is the various institutions of provincial and municipal governments; and the third is the relevant intermediary institutions (such as auditing agencies, valuation agencies, legal agencies, underwriting agencies, and public relations consultants), all of which enjoy certain administrative privileges by on the government.
Regarding the first obstacle, it is generally composed of three peaks (e.g., three government departments), with each department having three levels of institutions (e.g., ministries, bureaus, and divisions) handling the application materials of enterprises. At the first level (e.g., "division"), there are three parallel institutions with decision-making power, and each level has three layers of personnel (e.g., division heads, deputy division heads, and lead officers) to review the materials. To "network" with everyone requires passing through three or four "middlemen" to facilitate connections. To get acquainted with one person requires three rounds of entertainment (including dining, entertainment, travel expenses), with each round averaging 3,000 yuan or more. This would cost (2,187 × 3,000 yuan) = 6,561,000 yuan. This is what I summarize as the "slippery" phenomenon (a pun on "656"). The enterprise is like a dog being repeatedly "walked" by people. This 6.56 million is just the money spent on the surface, all of which is reimbursable with invoices. If the enterprise "networks" well and successfully goes public, this tens of millions of costs will either be recorded in the issuing entity's accounts, leading to falsified accounting; or they will be recorded in the controlling shareholder's accounts, forcing them to "appropriate" the interests of the listed company to comply with the principle of economic interest compensation. These costs (or benefits) revolve around "administrative privileges," which in economics are called "rents," and the entire process is called "rent-seeking." When listed companies spend "rents," they inevitably seek "excess profits." Thus, the entire system is designed such that the issue price (planned price) and trading price (market price) must have a significant "price spread." The vested interest groups can benefit from this spread, thus maintaining a balance of interests. As for enterprises, under the current system, they can only "take it or leave it." A truly outstanding company seeking an IPO undergoes such repeated "networking" (in reality, a form of torture), with significant losses in terms of human resources, finances, and materials. By the time the application is approved—when the IPO is granted—the company is already scarred and no longer "truly outstanding." Therefore, this seemingly glorious "proof of excellence" process is actually a "proof of inferiority"—this is the "IPO Paradox"!
If this enterprise truly has "unbeatable strength" and can maintain excellence, thus meeting the conditions for a rights offering, its major shareholders (holders of state-owned and legal person shares) may have to buy the rights at a price of 10 yuan per share (slightly below the market price, which might be 12 yuan), but if they later want to sell these shares, they can only do so at a price of 3 yuan per share (based on net asset value). Such a bizarre situation is considered "uncontroversial" under our system. This structure clearly contains elements of imbalance and is therefore temporary, destined to be replaced by a new one. Times are still progressing, and continuous innovation is the lifeblood of the capital market. Our capital market can be summarized in one sentence: "The future is bright, but the road is winding." Overall, the "spiral upward" does not exclude the possibility of some setbacks at the local level. For example, the "innovation" path of China's industrial investment funds has been even more arduous. To some extent, it is more appropriate to say that China's industrial investment funds need to "re-establish" rather than "innovate." Because, industrial investment funds, which are largely in a blank state, already existed 13 years ago. At that time, there were more than 60 "old funds," such as the "Zibo Fund," distributed across the country. The "China Agricultural Bank Zibo Township Enterprise Investment Fund," approved by the competent authorities—the People's Bank of China in 1992 and listed on the Shanghai Stock Exchange—was one of them, and I was one of its planners and the main drafter of the application documents. However, even if the current difficult-to-produce "Management Measures for Industrial Investment Funds" are issued, they will still fail to achieve the public offering and listing transactions that existed 13 years ago. Why? Simply put, the interest—privilege structure has changed and become rigid.
What is a great cause? It is to study the original theoretical concepts of China's unique capital market, which have no precedent in history, and to develop strategies that can solidly solve China's practical problems. This is the historical mission and challenge for Chinese economists. As Marx once quoted from Aesop's Fables: "Here is Rhodes, here leap!"
Since the early 1990s, teachers and graduate students at Peking University have been studying investment banking knowledge. They have not only eagerly absorbed relevant knowledge from abroad but also studied the characteristics of China's capital market and even engaged in practical operations to promote its development. It is precisely this long-term spirit of "focusing on cultivation without asking for rewards" that has made investment banking a classic course at Peking University, combining theoretical originality with first-hand case studies. The theoretical system and framework we have summarized—"with the general model of asset management as the foundation, the analysis of corporate and asset cash flows as the core, generalized asset securitization and corporate restructuring as the two main threads, and internal management and external regulation as the two auxiliary threads"—has gained widespread recognition and acclaim.
This series of books includes nine specialized topics that are most distinctive in investment banking, with an author team composed of professors, doctoral supervisors, and finance doctors from Peking University, representing the crystallization of long-term theoretical research and practical experience. We have launched these eight books as a summary of important courses for graduate, undergraduate, and advanced students of finance at Peking University, hoping to exchange ideas with peers and aspiring individuals, and to receive positive feedback and upgrades.
We thank the editors of China Development Press for their hard work and the enthusiastic support of the readers!
He Xiaofeng
End of 2005, by the East Bank of Weiming Lake