For the Chinese government foreign capital and management skills are vitally important in the mergers and acquisitions market if the country is to achieve its presumed economic goals. For international investors the mergers and acquisitions market in China offers another channel for participating in this growing economy and reaping financial rewards.

Investment Channels.

Foreign investors have three channels for carrying out equity investments in China: one is to buy listed stocks of Chinese companies, another is to set up a joint venture with a local company, and the third is to acquire part or all of a Chinese company. The three channels span a spectrum of investment characteristics, with stock markets and joint ventures at either end and acquisitions in between.

Stock Markets.

Two stock exchanges have been established in China since late 1990, one in Shanghai and the other in Shenzhen. Besides that, approximately twenty Chinese stocks are listed on the Hong Kong Stock Exchange, New York Stock Exchange, and other markets. Even though the domestic exchanges are experiencing rapid growth and a few more stock exchanges are likely to be established, it seems certain that the listed companies will remain a small fraction of the 100,000 state companies and millions of collective enterprises. Such an investment channel therefore will remain of narrow scope even if the access barrier for foreigners is completely dismantled. Some investors may also hesitate to choose this channel because of the excess price volatility and the irregularities typical of infant stock markets as well as the fact that the stock markets are subject to the government's intervention. Investing in stocks does offer the advantage of liquidity, though, which streamlines an investment process down to portfolio management (buying and selling) and thereby relieves the investors of involvement in the operational details of the underlying companies. Because it does not require fine-tuning the management of a company, such an investment channel is accessible to a wide variety of investors who may not possess technical expertise in the underlying business.

Joint Ventures.

On the other end of the spectrum as investment opportunities for foreigners are joint ventures, which have been the most common form of direct investments in China since economic reform began in 1978. A new joint venture enjoys preferential tax treatment: no tax for the first two years and half tax for the next three. There are drawbacks, though, because capital invested in a joint venture may have a low level of liquidity and cash flow may not be realized for a long time because of plant construction. A joint venture involves detailed management, and investors using this approach are usually companies already in the same business.

Acquisition.

Acquisition of part or all of an existing company is an investment approach that in some respects falls between the above two. Compared with setting up a joint venture, acquisition takes a shorter "time to start production and see cash flow. It is also easier for the investors to sell the acquired firm after repackaging it. To protect against this risk, many joint ventures are restricted from ownership transfer by contract. Investors may choose to get involved in the technical and managerial details of an acquired company, as they would do in investing in a joint venture. Or they may choose not to get involved, as in stocks. Either way, an investor's degree of control of management is predicated by the share of ownership. Since the daily operation may not be necessarily attended to if so chosen, such an investment opportunity may be accessible to a bigger pool of investors, who are not necessarily experts in that particular trade, through holding companies.

Investing through acquisition also offers the advantage of less government intervention than forming a joint venture or purchasing listed stocks. Acquisition is a means around several restrictions. In some industries, for example, there is a cap on ownership share of foreign investors in a joint venture. Further more, management in any joint venture has to be equally shared between the foreign and local shareholders, irrespective of their ownership shares. In the stock markets, a foreign investor cannot own more than 5 percent of a company's stock. In comparison, a foreign investor may acquire either part or all of a target company, and his control of the management is always weighted fairly by his share.

Special Concerns.

Foreign investors may have concerns about whether the contract in a merger and acquisition deal (or any other commercial deal) will ultimately be honored and whether business disputes will be fairly arbitrated. For protection, many insert a clause in the contract that allows them to bypass the Chinese courts. Such a clause specifies that disputes would be taken to the China International Economic and Trade Arbitration Commission (CIETAC) for judgments. CIETAC was created in the late 1980s when the Chinese government joined the international agreement 1958 New York Convention on the Enforcement of Foreign Arbitration Awards. By doing so, the government promised to honor any arbitration involving Chinese institutions or companies, made either in China or abroad.