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Home / Issues / Volume 10, Number 1 / Do Auctions Matter? Assessing the Chinese Auction Promotion Institution of Takeover Law
VOLUME 10, NUMBER 1
Do Auctions Matter? Assessing the Chinese Auction Promotion Institution of Takeover Law
By Charlie Xiaochuan Weng | Article | 10 Tsinghua China L. Rev. 49 (2017) | Download Full Article PDF

Abstract
This research examines the traditional wisdom of takeovers and relevant regulations. Generally, takeovers have a value adding effect, but need to be regulated in order to curb excesses. Auction promotion rules are efficient in maximizing social wealth and reducing non-value maximizing takeover deals when shareholders are confronted with a coercive offer. China has adopted such a rule. However, the application of the rule is far from satisfaction. The rule is not only ineffective in terms of its application ratio, but also reinforces controlling shareholders’ powers, which makes minority shareholders more vulnerable to controlling shareholders’ expropriation.

This research first conducts an empirical study on Chinese shareholder distribution in listed firms. Based on these up-to-date results, this article then analyzes, from an agency problem perspective, the utilities of different types of controlling shareholders in the market. This paper concludes that the current auction promotion rule, namely the “5% rule,” is not efficient in light of the common Chinese ownership structure. An ex ante announcement institution is suggested in order to compensate for the defaulting functions due to the deactivation of the rule. Finally, this paper introduces an opt-in legislation mode for the minority companies with dispersed shareholder distributions.



I. Introduction

Takeovers is a quintessential corporate law topic that attracts attention from both academics and professionals in industry. Voluminous legal and economic literature focus on finding an optimal takeover law model. The discussion on the best takeover institution became heated when the takeover market was booming. Market dynamics significantly influence the design of takeover institution. Although Professors Hansmann and Kraakman did conclude that corporate laws in different jurisdictions share many similarities, takeover law is probably an inevitable exception. Understanding the differences across jurisdictions entails extensive and detailed research on political interests, ownership structures and law enforcement, all of which may explain the diversity.

The general purpose of takeover law is almost amorphous. Even if shareholder protection serves as a broad explanation, there exist fierce debates as to which group of shareholders should be protected: those of the bidders or those of the targets?

The starting point of the debate is how to maximize social wealth. To be sure, the institutional avenues for maximizing social wealth through takeover vary, given the fact that corporate law in most cases maximizes social wealth through minimizing the costs incurred by agency problems, which differs from country to country because of diverse ownership structures. Despite this institutional diversity, it seems that maximizing social wealth should be one of the main legislative purposes of takeover law. National interests (or political interests under the cover of public interests), being protected through administrative takeover review, tax law, or antitrust law, also cannot be neglected. In order to achieve the aforesaid purposes, legislatures in different jurisdictions need to stipulate takeover regulations in light of specific national conditions.

It has been two decades since the first national stock exchange was established in China and the landscape of the Chinese capital market has changed significantly since. In the first decade after the establishment, state owners were almost omnipresent among listed companies. After the state-owned share reduction reform and State-owned Enterprises (SOEs) reform, the portion of state-owned shares has declined sharply. Despite these changes, SOEs are still dominant in the two exchanges: the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE). Meanwhile, these changes have nevertheless complicated the market composition and provided market forces that were conducive to marketization reform.

To be sure, it was the State Council (SC), the highest administrative authority in China, which initiated the economic reform and the “Open Gate Policy” at the end of the 1970s. SC purports to transition the Chinese economy from inefficient planned economy mode to market economy mode. This achievement, of course, is outstanding. The administrative-power-oriented-transformation model, however, invited a chronic disease for the later Chinese reforms: Path Dependency. It is unlikely that any reform thereafter could be successful without the support of administrative power. Thus, the development of capital markets requires administrative involvement. So far, onerous administrative approval procedures are widespread in the primary and secondary securities markets, and are not conducive to China’s marketization. Without the market supervisory authority’s “rubber stamp,” many fundamental operations are illegal or even criminal. Admittedly, this path dependency is indispensible in fueling Chinese reform, yet sometimes it not only distorts markets but also eclipses characteristics of the market economy. We, therefore, have to seriously consider the State’s interests in designing new takeover institutions to keep them viable within China’s path dependent context.

In the past, hostile takeovers hardly happened. The highly concentrated ownership structure and rigid hostile takeover law chilled the takeover market in China. The possible reason for the rigid and mismatched takeover law might be the same as for China’s Asian neighbors (such as Korea)- pressure from international financial institutions. However, this rigidity did not mean that there were no takeovers at all. Friendly takeovers were quite frequent in the past. From 2010 to 2014, Chinese capital market has seen more than 18,000 mergers and acquisitions involving listed companies. In a capital market with more than 2000 listed companies, the total should be a sufficient evidence showing the vitality of the takeover market. Despite these facts, we still need to ask whether Chinese takeover law works well or not. According to the aforementioned purposes of takeover law, did the law maximize social wealth? Did the takeover law properly represent national interests?

It seems that auctions in control transactions is the crucial and optimal method to maximize social wealth, even if there were different points of view. Chinese takeover law, as a transplanted legal institution, is not an exception to the auction promotion paradigm. There are institutions in the law providing for crucial delay, which is indispensable for promoting auctions. Meanwhile, past empirical research informs us that the existence of auction-related regulations is not necessarily associated with the occurrence of auctions. Although there were a lot of auctions happening, these occurrences do not mean that the law is maximizing social wealth. To be sure, regulations promoting auctions chill takeovers. Therefore, excessive delay also incurs social costs. This article focuses on the auction promotion issue in Chinese takeover law and analyzes the efficacy of it. As a Socialism country with strong state presence, China presumably has a law that sufficiently, if not excessively, protects its national interests. In the process of analyzing auction promotion, it becomes necessary to also consider administrative review, one of the many reasons for delay.

Part II of the article examines the traditional wisdom of takeover and regulations. It explores the logic behind takeover regulations and the rationales of auction promotion regulations. Further, part III analyzes the landscape of the Chinese takeover market and showcases an updated research on the ownership structure of listed firms. Meanwhile, China's auction promotion rule is discussed in this part in order to provide a clear picture and a starting point for further normative study. In Part V, the research justifies the necessity of deactivating the auction promotion rule from the value-maximizing perspective. Also, an alternative solution, namely the announcement institution, is introduced for compensating the positive functions of the auction promotion rule. Finally, the research believes that deactivating the auction promotion rule while still leaving it available for companies to opt in would be efficient for the companies with dispersed ownership structures, although such companies only constitute a minority across Chinese listed firms.

 
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