GOVERNING EMERGING STOCK MARKETS 5 © Blackwell Publishing Ltd 2005. 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA. Volume 13 Number 1 January 2005 Blackwell Publishing Ltd.Oxford, UK CORGCorporate Governance: An International Review0964-8410Blackwell Publishing Ltd. 2004 January 2005131KEYNOTE ADDRESSGOVERNING EMERGING STOCK MARKETSKatharina Pistor* and Chenggang Xu * Address for correspondence: Columbia Law School, 435 W116th Street, New York, NY 10027, USA. E-mail: kpisto@ law.columbia.edu Governing Emerging Stock Markets: legal vs administrative governance Katharina Pistor* and Chenggang Xu Transition economies face a fundamental dilemma. They need to develop financial markets, and yet they lack the ingredients it takes to do so. Recipes for legal governance mechanisms that have worked elsewhere, including reactive law enforcement by courts and proactive law enforcement by regulators, may not help in the short to medium term. Using evidence from stock market development in China and Russia, this paper suggests that at least in the short term, administrative governance may be a viable alternative to legal governance in emerging stock markets. Keywords: Emerging stock market, legal governance, administrative governance, China, Russia Introduction inancial market development is highly contingent on effective governance struc- tures. Recent literature has focused almost entirely on legal governance mechanisms, in particular on courts and regulators (La Porta et al., 1997, 2004). The standard policy pre- scription that has followed from this literature has been the transplantation of law and legal institutions from countries with developed financial markets to newly emerging ones. Yet, these transplants have not produced the desired results, at least not in the short term. Evidence from transition economies suggests that – contrary to the predictions of the law and finance literature – neither the level nor the change in shareholder rights protection in formal law has had a measurable impact on financial market performance (Pistor et al., 2000). This paper offers an explanation for why this might be the case and suggests how transition economies may nonetheless jump- start financial markets. We identify two key conditions that under- mine classic forms of law enforcement that have been tried and tested in developed mar- ket economies: the level of incomplete law, F and the absence of reliable information. Tran- sition economies have conducted extensive legal reforms, in many cases by transplanting law from more developed market economies (Pistor, 2000). The scope and meaning of newly enacted laws, however, is difficult to discern from statutory law alone. Due to lang- uage, cultural and institutional differences, case law from other countries that may help interpret the law is not easily transferable. Countries that transplant laws from else- where, therefore, have little or no access to interpretative sources, which makes trans- planted laws further incomplete. As a result, these laws cannot effectively deter violations, because they do not unambiguously specify the scope of actions that are considered a vio- lation of the law (Pistor and Xu, 2003). Only after a substantial body of domestic case law has been developed will issuers, investors as well as law enforcers know the reach and limits of the new law. Moreover, courts in transition economies often lack capacity and experience to address new legal problems effectively, which aggravates the problem of incomplete law. A standard device in developed markets for improving law enforcement when court