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What can economists learn from contract lawyers?

A Law and Economics Perspective

Qi Zhou

This chapter aims to stimulate a debate on the role played by lawyers in law and economics scholarship. It is argued that traditional legal scholarship is unfairly undervalued in the current law and economics movement. By using examples in English contract law, this chapter argues that lawyers can make three invaluable contributions to law and economics research. First, lawyers can improve economists’ understanding of contractual activities and the application of law in practice. Second, lawyers can assist economists in finding the flaws and limitations in their economic models. Third, lawyers can transfer proposals made by law and economics scholars into legal reform. It is argued that the success of law and economics in the future is dependent upon mutual respect and productive collaboration between lawyers and economists.

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Tianshu Zhou and Wenjing Li

This chapter makes two important contributions to insider trading research in China. First, from a purely legal perspective, it remains unclear whether recklessness constitutes sufficient grounds for the China Securities Regulatory Commission (CSRC) to punish corporate insiders who leak inside information to tippees without an interest-exchange, or whether the CSRC can punish only de facto conspiracies in which the tipper deliberately provides material information to benefit a tippee. Second and more importantly, beyond these sophisticated technical issues, research on the enforcement strategy of tipper liability has important implications for China’s regulatory and legal institutions. Are the courts meant to act as a check on the CSRC’s power through judicial review? Is the regulator equipped with sufficient resources to address the wide range of insider trading activities in China? Finally, is the regulator under the control of powerful insiders or otherwise corrupt?

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Jiye Hu and Yang Chen

Could institutional investors contribute to the stability of capital markets? The recent 2007–2008 American subprime mortgage crisis and the 2009 European sovereign debt crisis provided a good answer. Although the impact of the two financial crises is still felt across their respective geographies, European debt crisis countries, especially Greece, continue to lag behind; at the same time the US stock market recovered rather quickly from the subprime mortgage crisis. What explains the different performances in these countries? There are a large number of academic explanations; this chapter explores the factors that help to explain the difference in the recovery paths by using data from some OECD countries, and aims to explain what role institutional investors (or the lack thereof) play in the respective recovery paths of the US and European debt crisis countries. From the OECD countries data we can see that institutional investors played an important role in constructing a mature capital market, maintaining capital market stability and preventing a potential financial crisis. China has published several state normative documents to promote the development of institutional investors. It is expected that this will lead to a smoothing of the volatility of China’s capital markets.

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Niels Philipsen, Stefan E. Weishaar and Wenming Xu

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Jiajia Dai, Shiting Feng and Wenming Xu

This chapter employs a ‘shock-based’ research design to analyse the differences in the effects of the 2002 Notice concerning private securities litigation issued by the Supreme People’s Court on stock price performance in A/B_share markets. Using a sample of 162 twin A/B_shares issued by 81 listed firms, we find that the portfolio of B_shares, which are treated and held in large volume, obtains a significant positive treatment effect of 2.08 per cent relative to that of A_shares over a 3-day event window. In addition, a placebo test demonstrates that there is no difference in cumulative returns between A_shares of firms issuing both A_shares and B_shares and those of matched firms issuing only A_shares. Finally, we look into the determinants of the abnormal return between A/B_shares issued by the same firms and find that court efficiency is positively correlated with the magnitude of the abnormal return. Rational investors expect that compensation from private litigation will be determined by the costs of using the judiciary system.

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Tao Xi

In this chapter we look at the regulation of the commercial banking sector in China, which has been heavily relied on to meet the needs of domestic firms. Due to significant government ownership of banks, the role of the market is still rather limited as far as domestic banking is concerned. Against the background of a recent attempt of the central government to liberalize its banking sector, we analyse and propose a systematic reform plan to solve the incompatibility between the current regulatory framework and ‘normal’ business practices. First, the comprehensive management of commercial banks raises new challenges and no longer fits with the separate regulation of different financial sectors. In addition, there are significant conflicts between market incentives and national industrial policy when commercial banks extend their loans to companies with a high share of state ownership. Public regulators often make business decisions for commercial banks, and this should be restrained. Finally, the implicit governmental guarantee for deposits in banks generates a moral hazard problem for domestic banks. We recommend that commercial deposit insurance should be established.

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A Law and Economics Perspective

Wenming Xu, Stefan E. Weishaar and Niels Philipsen

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Niels Philipsen

This chapter discusses one of the main areas of EU competition law: State aid. Like other areas of EU competition law, such as abuse of dominance and merger control, there is a clear shift towards a ‘more economic approach’ and a stronger focus on efficiency. However, this stronger focus on efficiency with regard to a politically sensitive area such as State aid is not self-evident, and also raises the question why other jurisdictions do not have a similar control over market intervention by States (US) or provinces (China). It also raises the question whether controlling the efficiency of government spending should be a task of the EU rather than Member States. The aim of this chapter is therefore to critically assess the changing goals of EU State aid policy, from market integration and equity to efficiency and fiscal discipline. Possible implications for China are also discussed.

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Jonathan Klick

This chapter reviews the empirical revolution in law and economics. Its growing reliance on natural or quasi-experimental research designs has increased the credibility and usefulness of scholarly work in this discipline. This evolution also offers great possibilities for China to overcome methodological deficiencies of law and economics research by drawing upon its well-functioning bureaucracy, large population and numerous jurisdictional units. By basing its regulatory reform on randomized field experiments, China is uniquely suited to systematically test its regulations and policies and provides important and robust lessons for other countries and jurisdictional units.

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Binwei Gui, Michael G. Faure and Guangdong Xu

In this chapter we test the applicability of the environmental Kuznets curve (EKC) to China and find that, at least for certain pollution indicators such as industrial waste gas and SO2, there is indeed an inverted U-shaped trend that conforms to the prediction of the EKC. In addition, we explore the role of institutions in shaping the connection between income and pollution in China, and find that institutional variables to a large extent account for the heterogeneity in EKC patterns in China’s different regions. Finally, we examine the channels through which institutions may influence pollution control and environmental quality, and find that institutional indicators affect the pollution level through the operational outcomes of pollution abatement measures rather than by affecting structural transformation or the volume of pollution abatement facilities.