Capital Market Theory and Operations (Peking University Investment Banking Series)

Author: He Xiaofeng, Han Guangzhi
Publisher:
Publish Date: 2006-03-15
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 remain elusive, awaiting diligent 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 knowledge domain where innovation and practicality are highly integrated, and professionalism and diversity are harmoniously unified.
Looking back at the 15-year development of China's capital market, it has followed an incremental reform model. What is "incrementalism"? 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, and temporary balances give rise to more unbalanced factors, which are then broken by growing 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 part of it, it is hard to 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 excellent enterprises in certain regions of China to seek listing, they face two major hurdles: one is the government approval process, and the other is the market test, which often loses its "favorable timing" after passing the first hurdle. Only about 1% of enterprises that pass both hurdles may succeed. It is truly a case of "one hero's fame is built on the bones of countless others."
Let's first discuss the first hurdle: the government approval process. A truly excellent local enterprise faces three major obstacles: the first is various institutions under the central government; the second is various institutions at the provincial and municipal levels; and the third is intermediary institutions (such as auditing, evaluation, legal, underwriting, and public relations agencies), 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., ministry, bureau, and division levels) handling the enterprise's application materials. At the first level (e.g., division), there are three parallel institutions with decision-making power, and each level involves three layers of personnel (e.g., division heads, deputy division heads, and lead officers). To "network" with everyone, one must go through three or four "middlemen" to facilitate connections. To get acquainted with each person, one must entertain them three times, with each entertainment (including dining, entertainment, travel expenses) 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 (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 issuer's books, leading to falsified accounting, or recorded in the controlling shareholder's books, inevitably "invading" the interests of the listed company to comply with the principle of economic interest compensation. These costs (or gains) revolve around "administrative privileges," which in economics are called "rents," and the entire process is called "rent-seeking." When listed companies spend "rents," they must 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 then benefit from this spread, maintaining a certain interest balance. As for the enterprises, under the current system, they can only "take it or leave it."
For a truly excellent company to apply for listing, the process of proving its "excellence" is a torment, causing significant losses in terms of human resources, finances, and materials. By the time the proof is complete—the approval for listing—the enterprise is already scarred and no longer truly excellent. Therefore, this seemingly glorious "proof of excellence" process is actually a "proof of inferiority"—this is the "IPO Paradox"!
If this enterprise truly has an "unbeatable" quality and can maintain excellence, thus meeting the conditions for a rights issue, its major shareholders (shareholders of state-owned and legal person shares) may have to buy the rights issue at a price of 10 yuan per share (slightly below the market price, which might be 12 yuan). However, 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 local setbacks. 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 "revitalize" rather than "innovate" at present. Because industrial investment funds, which were almost non-existent 13 years ago, already existed then, with "Zhufu Fund" and other "old funds" numbering over 60 and distributed across the country. The "Zhongnongxin Zhufu Township Enterprise Investment Fund," approved and established in 1992 by the competent authorities (People's Bank of China) and listed on the Shanghai Stock Exchange, was one of them, and I was one of its main planners and drafters of the application documents. Yet, even if the current draft management measures for industrial investment funds are implemented, they cannot 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 academic pursuit? It is to study original theories of China's unique capital market, rooted 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 dance!"
Since the early 1990s, teachers and graduate students at Peking University have been studying investment banking. They not only avidly absorb relevant knowledge from abroad but also study the characteristics of China's capital market and even go into practice to learn operations, driving the expansion of China's capital market. 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 firsthand case studies.
The theoretical system and framework we summarize—"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 with the most distinctive features of investment banking, authored by a combination of professors, doctoral supervisors, and finance PhDs from Peking University, representing the crystallization of long-term theoretical research and practical experience. We have published these eight books as a summary of important courses for graduate, undergraduate, and advanced students in finance at Peking University. We hope to exchange ideas with peers and aspiring individuals, receive positive feedback, and further refine them.
We thank the editors of China Development Press for their hard work and the enthusiastic support of the readers!
He Xiaofeng
Late 2005, by the eastern shore of Weiming Lake