China Entrepreneurs Seek Economic Freedom in U.S.

Ryan Olson / May 19, 2014

Alibaba, the Chinese e-commerce giant whose sales top eBay and Amazon combined, chose the U.S. as the location for its initial public offering (IPO) last week. Why did Alibaba consider the U.S. and Hong Kong for its IPO over China, its biggest market? The answer is economic freedom.

China’s auditing and accounting standards are abysmal. This makes it difficult for markets to accurately price the valuation of large IPOs because investors can’t analyze a company’s balance sheets or determine assets, liabilities, and cash flows. As a result, Alibaba, along with other big Chinese companies such as Weibo and JD.com, have been jumping to U.S. stock exchanges, where economic freedom—and valuations—are higher.

China’s illiberal financial sector has allowed its leaders to funnel deposits to state-owned banks, control credit and investment, and limit the interchangeability of the currency, the renminbi. This financial oppression has benefited well-connected banks, but it hasn’t contributed to the creation of a vibrant financial sector that allocates capital efficiently.

Corruption also plays a role. In 2012 the U.S. Securities and Exchange Commission started proceedings against four U.S. accounting firms for failing to disclose documents in the fraud investigations of Chinese companies. The Chinese government has since barred the SEC from viewing these companies’ financial statements, a move some claim is aimed at hiding fraud, embezzlement, and bribery.

All of this boils down to the lack of economic freedom in China’s financial sector and investment regimes. According to the Index of Economic Freedom, co-published by The Wall Street Journal and The Heritage Foundation, China ranks in or near the bottom quintile in both investment and financial freedom. For protecting investors, including adopting good accounting and auditing standards, China ranks 98th in the World Bank’s Doing Business report.

According to Heritage’s newly released Global Agenda for Economic Freedom:

It is difficult to attract investors without clear private-sector transparency, so adopting Western-style auditing and accounting standards is paramount. Listing on foreign exchanges with superior reporting standards (such as London, New York, or Hong Kong) has generally elevated a company’s auditing standards and valuations.

China’s economy will soon become the largest in the world by surpassing the U.S. based on purchasing power parity. However, Chinese businesses don’t seem too impressed. The country’s most innovative companies continue to flee the middle kingdom to find financing where there is more economic freedom.