The agency problems in China’s private equity investments: a cross-jurisdictional perspective

This thesis aims to identify and solve the agency problems in the life cycle of private equity (PE) investment under the commercial law system in China by comparing the legislative and adjudicative practices in the United Kingdom (UK) and other related jurisdictions. Based on transaction cost economics as the theoretical foundation of this research, the agency problems of PE investment derive from the two-level separation of ownership and control, one of which is the principal–agent relationship between the PE investors and the fund manager, and the other is the principal–agent relationship between the PE shareholders and the management of investee companies. As effective institutional solvers to agency problems, fiduciary duties as default rules have been widely developed and practised in common law countries to protect the interests of PE investors. Subject to the strong dependency on judicial practices, however, the economic function of fiduciary duties may not be fulfilled properly in the jurisdictions without a sound and independent judicial system such as that in China. Therefore, the logical purpose of this research was to find a series of feasible and costefficient approaches to reduce the agency costs in governance of three organizational structures that are involved in PE investments under Chinese legal and regulatory regimes, namely the limited partnership, business trust and corporation. As the society and economy of the UK are developed along a free-market and liberalistic ideology, the contractual freedom as the core spirit of the UK‘s commercial law has been widely accepted and recognized in both legislative and adjudicative activities. Thus, both the decision-making rules in PE funds and corporate governance of portfolio companies in the UK are also labelled as showing high respect for contractual autonomy. The protective rules sprung from common law and equity in relation to the laws of business organizations and trusts also provide flexible approaches for reducing agency costs in PE investment. Hence, this thesis especially underlines the reference to, and transplantation of, the contractual techniques of the UK‘s business organization law for enhancing investor protection of the Chinese PE industry, by which the negative impacts of political intervention and uncertainty in judicial practices may be effectively constrained. In addition, in order to make this analysis more comprehensive and objective, this thesis also refers to the institutional transplantation of trusts and corporate governance in not only continental and mixed jurisdictions, but also several typical transitional economies in the world. Based on, and beyond, the aforementioned research, this thesis argues that the basic legal framework of PE has undoubtedly been established in China. This notwithstanding, the strong state capitalistic ideology and authoritarian interest pattern still seriously impede the legal reform towards a more market-directed and investor-protection-oriented institutional construction. In a broader sense, another conclusion may also be put forward, namely that the transplantation of different business organizations across jurisdictions are determined by the distribution of the costs of protecting investors. As a brief model, the costs of investor protection are divided into internal and external approaches; the former refers to the cost of contractual arrangements within business organizations and the latter to the costs that are generated from the judicial and regulatory activities outside business organizations. Based on a detailed economic analysis of the main types of business organizations, this research concludes that 1) when the organizational and non-organizational protective approaches generate equal costs, such an organizational form should be most widely applicable and transplantable; and 2) the success of such legal transplantation depends on whether the gross costs of protecting investors can be reasonably distributed by the organizations and regulatory and judicial systems. The developing path of the commercial law system in China may preliminarily illustrate the above thesis, while more detailed studies may be developed in future.