Deterrence and Regulatory Failure in Emerging Financial Markets: Comparing China and Russia

660_pistorxu.pdf315 KB


Transition economies faced the formidable task of creating financial markets to ensure that enterprises gained access to external sources of funds under circumstances that were unfavorable for such markets to take off. The two major obstacles for financial market development we identify in this paper are highly incomplete law and the absence of reliable company specific information. We argue that in light of these obstacles standard law enforcement practices, including deterrence and reactive law enforcement by courts, and ex ante screening and proactive law enforcement by regulators are not effective. To jumpstart financial markets under these circumstances, other avenues have to be explored. We suggest that China, but not Russia, has been quite successful in seeking such alternatives. We identify the decentralized process of selecting companies for listing on major stock exchanges as a means for collecting company specific information that cannot be easily standardized and would therefore remain unexplored in a system that relied only on financial reporting and disclosure. While state agents involved in the selection process may have incentives to select lemons rather than viable firms for listing, we argue that the competition among different regions and ministries instilled by the so–called quota system has mitigated these dangers. By contrast, Russia?s reliance on a standard Western disclosure system with law enforcement by a combination of courts and regulators not paid off so far. On the contrary, uncertainties about the effectiveness of law enforcement and absence of reliable information have restrained financial market development. Evidence on lower co–movement of stock in China than in Russia lends support to our theoretical analysis.



Last updated on 03/25/2015