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China is prime territory for venture capitalists, according to Jack Wadsworth, ’63, one of the first American financiers to break into Asian markets.
Over the last 30 years, top venture capital firms—particularly those in California—produced huge returns, but now average venture capital returns in the United States have plummeted, he said. “Is there an opportunity somewhere else in this world where the phenomenon works? I think China is the place.”
Wadsworth, retired chairman of Morgan Stanley and member of the Council on the Graduate School of Business, spoke May 4 to students in the Strategy Symposium class taught by Harry Davis, Roger L. and Rachel M. Goetz Distinguished Service Professor of Creative Management, at the Charles M. Harper Center.
Wadsworth, who led Morgan Stanley when the firm expanded its business into Japan in the 1980s, sees China is going through similar regulatory problems now—specifically related to commissions and the amount of income derived from them. A successful venture capital industry requires entrepreneurs, managers, a big market with dramatic changes, and a government with friendly policies. “In China you have all of those ingredients,” Wadsworth said.
When Wadsworth left Morgan Stanley in 2001, he launched Manitou Ventures, a venture capital firm, which partners with Chengwei Ventures in China; the firms invest primarily in information technology in China.
Wadsworth credits the transformation of Japanese and Chinese markets to American ingenuity and ideas—specifically, University of Chicago ideas—about capital markets and efficient markets.
“Having been there at the firewall as we developed our strategies for both of those countries, I think when we look back in a few years, it will be possible to say we did have a huge impact,” said Wadsworth.
A pivotal moment came in May 1975 when the U.S. government declared that stock commissions would no longer be fixed but be negotiated. That decision streamlined the U.S. financial industry, he said. “In the intervening 10 years, the firms that were not strong disappeared,” Wadsworth said. “The firms that were capable of adjusting to this new world added capital and technology, added brain power, came to Chicago to recruit, and focused on innovation.” Only about four or five firms survived. They have grown to become the “global juggernauts of finance today,” he said.
Morgan Stanley was one of the six firms invited to join Japan’s stock exchange in 1986.
“Believe you me, we were shocked,” Wadsworth said. “Everybody in the world had applied for a license to join the stock exchange. We were a relatively small firm. But unbeknownst to us, through our institutional trading activities, we had huge flows through the Tokyo stock exchange through brokers in Tokyo and through our customer flow.”
Wadsworth was chosen by the Morgan Stanley president to go to Japan to build the business. He and his wife arrived in Tokyo on September 9, 1987.
“I had done just enough research on the Japanese financial industry and on the players to be scared to death,” he said. “In 1987 the fifteen largest financial institutions ranked by market cap in the world were 100 percent Japanese.”
Over the next ten years, the situation changed as American firms rose to the top of the Japanese market, Wadsworth said. But early on, making reforms to the Japanese market became the biggest challenge for American firms, and Wadsworth concentrated his efforts there. In 1987, the top four Japanese banking firms derived 85 percent of their top line revenues from commissions, Wadsworth said. In contrast, top United States firms, more diversified and efficient, were down to 8 percent of revenues from commissions.
Wadsworth decided that rather than compete with Japanese financial institutions “for whatever slice we could get” of its traditional market, he should instead spend most of his time working on deregulation.
For example, one aim was to depoliticize the stock market and ensure that stock prices and interest rates instead hinged on supply and demand.
Wadsworth also worked to ensure that Morgan Stanley was first to have its foot in the door in China. He started by establishing a joint venture with China Construction Bank.
He discovered that China’s regulatory problems mirrored those in Japan’s past. While sitting on China’s regulatory authority, Wadsworth heard a presentation on China’s securities industry, which showed 60 percent of its firms were failing, with most of their income derived from fixed commissions. Only one securities firm was diversified: it was the top firm, China International Capital Corporation, and it was the joint venture Wadsworth had helped to start ten years earlier.
Morgan Stanley owns a 34 percent share of CICC and is still waiting for China to open its stock exchange and free up its capital markets, Wadsworth said.
Second-year student Sean O’Malley said he was amazed by how Wadsworth “knew how to make the right moves in completely uncertain, almost untenable situations.”
—Mary Sue Penn