Agency problems and liquidity premium: Evidence from China's stock ownership reform

Abstract

Before the split share structure reform, China's publicly listed companies in domestic stock exchanges had two classes of stock: tradable and non-tradable shares. These two classes of stock had the same voting, cash flow, and all other legal rights except that non-tradable shares cannot be transferred at the open markets. From 2005, China implemented the reform to convert all non-tradable shares into tradable. In this reform process, the holders of non-tradable shares had to negotiate with their tradable counterparts to determine how much liquidity premium, or the compensation ratio, to pay the holders of tradable shares in order to obtain the liquidity right. Unlike previous studies, this paper starts with a theoretical model to identify the fundamental factors, including price discount before and after the reform, the percentage of non-tradable shares, the volatility of tradable share price, and the lockup period, that should determine the compensation ratio. We show that most of these factors are statistically significant in determining the compensation ratio. However, the agency problems induced by state and mutual fund ownerships weaken the role of the fundamental factors in determining the compensation ratios.