Regulatory Visions and the State in E. Asia: The Irrational Investor Problem in the Comparative Politics of Finance

• Published date: 01 November 2023
• DOI: http://doi.org/10.1177/00104140231169015
• Author: John Yasuda
• Date: 01 November 2023
• Subject Matter: Articles

Article

Comparative Political Studies

2023, Vol. 56(13) 2066–2098

© The Author(s) 2023

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DOI: 10.1177/00104140231169015

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Regulatory Visions and

the State in E. Asia: The

Irrational Investor

Problem in the

Comparative Politics of

Finance

John Yasuda

Abstract

Despite the marked transformation in E. Asia’sf‌inancial systems, regulators

continue to employ hard paternalistic approaches to their stock markets that

are viewed as counterproductive to their development. This article argues

that the persistence of hard paternalistic regulatory practices can be explained

by a regulatory vision—a common analytical framework to order complex

uncertain environments that serve as regulatory f‌irst principles—centered on

an irrational investor. A regulatory vision works alongside pressures ema-

nating from foreign investment, state capitalism, and state-business relations.

This understanding of investor rationality is in marked contrast to a liberal

market variant, which emphasizes a rational investor, and thus provides a

distinctive comparative lens to understand regulatory behavior in a moment

of global f‌inancial hybridization. The study draws on over 90 elite interviews of

senior regulators, stock exchange off‌icers, and market practitioners con-

ducted in China, Japan, Korea, and Taiwan, from 2015 to 2019.

Keywords

stock market, developmental state, f‌inancial regulation, paternalism, ideational

politics

Johns Hopkins University, Baltimore, MD, USA

Corresponding Author:

John Yasuda, Department of Political Science, Johns Hopkins University, Mergenthaler Hall,

Baltimore, MD 21218-2625, USA.

Email: Jyasuda1@jhu.edu

The state’s approach to stock market governance in E. Asia presents a puzzle

to scholars, pundits, and policymakers. An increased emphasis on shareholder

value, new innovation-focused stock markets, liberalized f‌inancial product

offerings, and growing, if not dominant, foreign ownership of listed com-

panies have fundamentally transformed the f‌inancial landscape of the region

(Tiberghien, 2007;Tsai,2017;Vogel, 2019). Despite these changes, regulators

still cling to hard paternalistic forms of regulation that are viewed to be

counterproductive towards developing a sophisticated capital market. A hard

paternalistic approach refers to regulation that severely constrains investor

choice ex-ante by outright bans and reduces the cost of bad decisions ex-post

(Klick & Mitchell, 2006). In contrast, soft paternalist regulation that is more

associated with liberal market economies, respects the autonomy of decision-

making by market participants (i.e., not reducing the choice set), but nudges

actors towards better decisions through the provision of information and how

options are presented to them (Sunstein & Thaler, 2003).

Across E. Asia, regulators engage in hard paternalistic practices much to

the chagrin of market practitioners. Since 2010, the Bank of Japan has en-

gaged in the controversial practice of purchasing stocks through its ETF

acquisition program to compensate for weak trading during the morning

session, leading many traditional participants to shun Japanese stocks (Lewis,

2019). In Korea, the regulator’s frequent bans on shorting the market, has

angered major fund managers, who argue they are deprived of a hedging tool

against inf‌lated markets (Song & Lockett, 2021). In 2021, MSCI, a global

index provider, decided to cut Taiwan’s weighting in three major indexes, its

ninth consecutive downgrade, due to “a lack of convenience in trading stocks”

(Wu & Huang, 2021). And, in China, currently undergoing an extreme f‌i-

nancial crackdown, regulators continue to intervene in markets and restrict

listing options for companies (Masters, 2021). These approaches towards the

stock market impede price discovery, contribute to moral hazard, and arguably

make it more crisis prone as a risk calculus never obtains among investors.

Why do regulators continue to employ hard paternalistic tools that appear to

undermine their efforts to build better stock markets?

This article argues that the deployment of a hard paternalist approach to

manage stock markets is driven by a state’sregulatory vision centered on an

irrational investor. Redeploying Steinfeld’s (2004) concept of a “market

vision,”a regulatory vision ref‌lects tacit common analytical frameworks that

order complex, uncertain environments, and serve as f‌irst principles to guide

regul atory behavior. This article focuses on the “who”ofa regulatory vision,

highlighting how a concept of an irrational investor operates as a regulatory

default leading to a hard paternalistic approach to listings management,

trading, and product innovation. This regulatory vision interweaves with

varying cross-pressures emanating from foreign capital, state capitalist or

developmental legacies, and state-business relations, which together

Yasuda 2067

ultimately shape whether states adopt stronger or weaker hard paternalist

approaches.

The existing literature provides little guidance as to how regulatory

conceptions of investor irrationality might affect market governance choices.

In comparative political economy, scholars of East Asia more broadly have

shown that policymakers have eschewed market rationality as a regulatory

principle (Naughton & Tsai, 2015;Vogel, 2006), but have yet to explore

regulatory skepticism of the rationality assumption in relation to investors.

Moreover, studies on stock market regulation and its relationship to modal

conceptions of investor behavior are drawn primarily from the Anglosphere,

in which regulation has emphasized a rational investor, which anchors a soft

paternalist system (Langevoort, 2006;Lin, 2015;Rose, 2017;Sachs, 2006).

This article turns the rationality assumption on its head and considers how a

state goes about regulating a market that it views as populated by irrational

investors.

The emergence of an identif‌iable regulatory vision in the stock market is

deeply consequential as an empirical and theoretical subject. For E. Asia’s

bank-centered economies, a robust equities market is viewed as crucial to de-

leverage corporate balance sheets, improve corporate governance, and foster

innovation in the economy (Eichengreen, 2014). But beyond economic

concerns, stock exchanges have become the sites of signif‌icant political

contention. First, stock market failures can result in swift political retribution

as prices collapse, leading to the ousting of ministers in Taiwan, altered

parliamentary outcomes in Korea, and social protests in China (Champion,

1997;Chan, 2008;Lee, 2022). Second, retail investors from Korean ants to

American reddit punters have used the stock market to pushback against what

they view as a rigged economy, challenging high f‌inance’s dominance of the

market by rallying to protect targets of acquisition through frenzied buying

sprees (Song, 2021). Third, shareholder governance has become an in-

creasingly important site for social activism, extending the reach of civil

society into the heart of the market, particularly as a matter of environmental

protection (Puchniak & Nakahigashi, 2012). The stock market has tapped into

deep underlying currents regarding fairness, sustainability, and globalization,

and thus understanding how regulators conceive of their modal investor is

politically consequential.

This research offers two contributions to the comparative politics of f‌i-

nance. First, it focuses on the core beliefs of regulators themselves, and

redirects our attention from how you regulate to who you think you regulate

(Storz et al., 2013). As argued by Thurbon (2016), discussions on the

transformations of E. Asian f‌inancial systems overwhelmingly consider the

changes in regulatory practices, with relatively less thought given to regu-

latory core beliefs, such as those about the nature of investor behavior and

their varying time horizons and liquidity needs. Second, Zysman (1983) has

2068 Comparative Political Studies 56(13)