Zhong Zhang | The University of Sheffield (original) (raw)

Papers by Zhong Zhang

Good corporate governance is crucial for the successful transformation of SOEs in China and the l... more Good corporate governance is crucial for the successful transformation of SOEs in China and the long-term success of Chinese economy. To improve corporate governance in China, the top priority is to curb serious managerial misbehavior such as misappropriation and fraud which has not yet been controlled. To achieve this end, market-based mechanisms are ineffectual, because they are not equipped with the ability to remove illegitimate benefits from misbehaving management or impose punishments on them. Only legal liability has this ability and can thus be effective in deterring serious managerial misbehavior. Legal liability comes from both the public and private enforcement of law. While the public enforcement of law produces harsher liabilities, it suffers from various limitations. Public law enforcement is particularly ineffectual in China where an accountable political system has yet to be established and law enforcement is impeded as a result of the dominance of state ownership in listed companies. For these reasons, the private enforcement of law is necessary. Both derivative action and securities class action are devices of private enforcement of law which produce legal liability, but derivative action is indispensable, not just because securities class action is unrealistic in China.

To enable derivative action to become a realistic corporate governance tool, appropriate legal rules should be put in place. The traditional common law, which is based on the dichotomy of actionable and non-actionable wrongs, seems irrational, because actually there is no such distinction. The company’s interest is the paramount test of the permissibility of derivative action and this, in turn, is determined by the purpose of company. While the new derivative action in China does not differentiate actionable and non-actionable wrongs, it adopts the strategy of setting a minimum shareholding requirement as the condition for bringing suits. From the experience of continental Europe and the US, such a strategy would ensure that derivative action would not be vigorously pursued in China. The strategy should be changed and an approach enabling derivative action to be decided case by case according to the test of the interests of the company should be adopted. If this strategy is adopted, it might be better to assign the responsibility of assessing a case to the court rather than to the company. The assessment should be based on the probability of success and the potential net recoveries from the case. Another defect of the new derivative action is that it does not mention the issue of litigation funding. Without appropriate funding rules, derivative action would not actually be taken. The American contingent fees are most favorable in terms of facilitating derivative actions and current experience of derivative actions in the US indicates that contingent fees would not necessarily lead to frivolous litigation.

Having grown to one of the largest in the world in just over two decades, the stock market of Chi... more Having grown to one of the largest in the world in just over two decades, the stock market of China is cited as a counterexample to the significance of law for financial market development. A thorough investigation of the history of China’s stock market development however finds that law is actually critical to sustaining market growth, in that China's stock market faced an existential crisis in the early 2000s as a result of pervasive market abuse and only after market abuse was greatly curbed by law did the market continue to grow. On the other hand, the trajectory of development in China is growth first followed by law and the improvement of law is driven by market growth. The experience of China hence indicates that law and market growth is in a bidirectional rather than unidirectional causal relation, and the course of development is “growth-law-further growth”. Nevertheless, this virtuous circulation is not a guarantee and market growth may not always lead to stronger law, evidenced by the fact that serious mismanagement is still widespread among listed SOEs in China. Political and ideological restrictions are the root obstacle. Politics and ideologies are fundamental to market development, for they not just obstruct the change from market growth to law, but also explain the growth in the first place. On the other hand, the strength of law is not predetermined by the legal origin of a country, and law can improve even in China, a country without the tradition of rule of law.

Despite the high expectation for the shareholder derivative action to play an important role in i... more Despite the high expectation for the shareholder derivative action to play an important
role in improving corporate governance in China, only one lawsuit has ever been
brought since it was formally introduced in 2005, so far as listed companies are
concerned. Above all, the 1% minimum shareholding that plaintiffs are required to
satisfy by law is a barrier to derivative suits. However, it is impossible to establish and
reduce the threshold figure to an appropriate level, and actually the minimum
shareholding requirement as a mechanism for screening out frivolous litigation is
inherently flawed. On the other hand, the nature of the derivative action determines
that the strategy based upon judicial control rather than a minimum shareholding
requirement cannot work properly in China, where the judiciary is weak,
unsophisticated and riddled with corruption. When the judicial system is in such a
state of condition, it is unrealistic that the derivative action—and, indeed, the private
enforcement of law in general—can play a significant role in corporate governance.
The findings in this paper raise a question of how corporate governance can indeed be
improved in a country where the judiciary is incompetent to perform its role.

There has been a high expectation for the derivative action, which was introduced into China in 2... more There has been a high expectation for the derivative action, which was introduced
into China in 2005 when the Company Law 1993 was extensively amended, to play an
important role in corporate governance in China. But this expectation may not be
fulfilled, because, among other things, the Law does not provide for how derivative
actions should be financed. By way of a comparative study, this article investigates
what rules are appropriate for derivative action funding in China. The general
conclusion is that the common law indemnity order is inherently defective, because it
entails that judges impose financial obligations on a company before the merit of an
underlying claim is ascertained. The American contingent fee is most favourable and
the established rules could be reformed to make the arrangement neutral so as to
discourage frivolous litigation. Lastly, the special barrier of filing fees in China has
to be cleared in order for derivative actions to be actually taken.

To evaluate the Chinese government’s recent market-orientated efforts to promote good corporate g... more To evaluate the Chinese government’s recent market-orientated efforts to
promote good corporate governance, this paper conducts a re-examination of the
working mechanics for market competition and other market-based governance
mechanisms to ensure good corporate governance. The finding is that the utility
of market mechanisms may have been overstated. Not only are they not effective
in disciplining serious one-off managerial misbehaviour which offers managers
more gains than losses, even their limited value to discourage such misbehaviour
as managerial shirking is also conditioned upon a successful curb on one-off
misbehaviour. On the contrary, the importance of deterrence from legal liability
may have been underestimated. Sufficient legal deterrence is the only effective
way to curtail one-off managerial misbehaviour which is highly detrimental to
corporate success. In addition, by deterring such misbehaviour, it provides for
the condition upon which market mechanisms may function properly to
discourage managerial shirking. In light of this, legal deterrence can be said
fundamental to good corporate governance. Current experience of corporate
governance from China conforms to this finding and poor corporate governance
in China is better explained by the lack of credible legal deterrence. This being
so, the top priority for China is to strengthen legal sanction in order to rein in
excessive misappropriation and flagrant fraud. Only once this has been done will
the efforts to undertake market-orientated reform yield the sought results.