Split-share Reform Research Articles

Stock Market Efficiency in China: Evidence from the Split-Share Reform

We perform an event study to investigate the efficiency of the Chinese stock market. We study the reaction of stock returns and trading volumes to the 2005-2006 structural reform which allowed the transformation of non-tradable shares (NTS) into tradable shares (TS) through payment of a compensation to holders of TS. We find evidence of positive abnormal returns in the few days before the announcement of which companies will undergo the reform process and in the ten days after the readmission to trading of participating companies following the determination of the compensation, but no abnormal returns after the payment itself. From a methodological viewpoint, our contribution is the introduction of a bootstrap procedure that is designed to replicate the actual degree of covariance across firms.

Is the Stock Market Just a Side Show? Evidence from a Structural Reform

The 2005 split-share reform in China mandated the conversion of nontradable stocks into tradable status. This paper examines the effects of stock markets on corporate outcomes exploiting multiple institutional features of the Chinese conversion program. Using a generalized propensity score matching approach, we identify increases in corporate profitability, investment, value, and productivity as a result of the reform. We also identify changes in firms’ likelihood to issue shares and engage in mergers, as well as changes in dividend and capital structure policies. Our findings provide insights on the role of stock markets in shaping corporate activity and on the impact of regulation on economic growth. (JEL G31, C21, O16, D21)

The Value Relevance and Information Content of Cash and Stock Dividends in China

The Chinese stock markets provide a unique experimental setting in which to examine how cash and stock dividends convey value relevant information about future performance and future cash dividends. Utilising market valuation equations based on Ohlson (1995), as well as prediction models, and applying them to a large sample of Chinese firms from 2003-2011, we find the following. First, stock dividends are positively associated with firm value, and convey information about future cash dividends and future earnings in the absence of cash dividends. Second, when cash dividends are paid, it is these that convey information about future cash dividends. Third, the value relevance and information content of cash dividends is stronger following the split share reforms and the adoption of IFRS, while the value relevance of stock dividends weakens over the same time period. Our evidence suggests that, in China, where the information environment is not as well-developed as in Western stock exchanges, stock dividends play an important role where cash dividends are not informative and this may help to explain their prevalence.

State-Stewardship Theory and Executive Compensation

We propose a state-stewardship theory competing with the traditional agency theory to explain the corporate governance model and executive compensation policy in China. Under China’s highly politically-oriented institutional environment, Chinese managers (business elites) are not just professional managers but also government officials (political elites) directly appointed – even in ‘private’ firms – by the state. Consequently, they do not face inherent conflicts of interest with the state, but are expected to act as responsible ‘stewards’ of the state. This state-steward relationship is amplified when more state-owned shares are sold to the market. We test the state-stewardship theory on all non-financial listed firms in China for the period 2001 to 2011. Consistent with our conjectures, we find that Chinese managers are paid much less than their international counterparts and that remuneration is lower in firms with larger state-ownership or stronger (ultimate) state-control. Also, Chinese managers seem to be remunerated not for maximizing equity value but for increasing the value of the state-owned assets. The board of directors only plays a symbolic role; it does not have much influence in terms of advice or supervision and does not seem to regulate managerial pay. Managerial duality does not seem to grant the general manager more power in influencing his own remuneration. Furthermore, managers’ remuneration is not linked to competence and personal traits, but rather to their political connections and prestige, and to the contribution that their firms make to the local, regional, or national (macro-)economic targets and hence the (local) officials’ political achievements. Most of the above effects are stronger in the pre-2006 period, because after the split-share reform of 2006, companies became more market-oriented though state influence still prevails. The results remain robust when we control for endogeneity, measurement errors, outlier effects, and sector and regional differences.

Split-share reform and earnings management: Evidence from China

This paper investigates the impact of split-share structure reform on earnings management in China. A unique institutional feature of China was the co-existence of two types of share that endowed all shareholders with equal voting and cash flow rights but different tradability. This split-share structure significantly constrained the tradability of shares that led the Chinese Securities Regulatory Commission to make it mandatory for the conversion of non-tradable shares into tradable shares from 2006 onwards. We investigate whether such a conversion has any effect on information quality through reduced earnings manipulation. We specifically examine the incentives for earnings management during the reform-transition period. A unique feature of the split-share reform has been the requirement for non-tradable share holders to compensate the tradable share holders. We argue that the rational response from the non-tradable share holders would be to pay a lower consideration to tradable share holders by portraying a favorable picture through income-increasing earnings management. We also test for the effect of an increase in tradable shares on earnings management during the reform-transition and post-reform period.

Foreign Institutional Investors and Corporate Governance in Emerging Markets: Evidence from Split Share Reform in China

Foreign Institutional Investors and Corporate Governance in Emerging Markets: Evidence from Split Share Reform in China

Foreign Institutional Investors and Corporate Governance in Emerging Markets: Evidence from Split Share Reform in China

We study the benefits of opening up local equity markets to foreign institutional investors using data on Qualified Foreign Institutional Investors (QFIIs) in China around the reform floating non-tradable shares. We find evidence supporting the view (Stulz (1999)) that as “outsiders,” foreign institutional investors are less prone to political pressure and are more likely to perform arm’s length monitoring than local mutual funds. In particular, the presence of QFII ownership shortens the duration of reform, enhances the terms in negotiation, and increases the compensation to tradable shareholders. We confirm that while state-controlled companies on average offer higher compensation ratio for a quicker approval, the state entities may exert political power and offer lower compensation ratio for companies with domestic mutual fund ownership (Firth et al (2008)). In contrast, we further find that the positive relation between state ownership and the final compensation ratio increases with the level of QFII ownership. QFIIs increase the likelihood of change in the compensation proposal among state-controlled companies, while local mutual funds show opposite effect. These results are unlikely due to endogeneity problem as local mutual funds and QFII have closely akin portfolio holdings and similarly positive effect on firm value. Our study suggests that the influx of large foreign institutional investors help promote market principle in corporate governance in emerging markets and alleviate the “twin agency” problem from state ruler discretion. (Stulz (2005))

Is the Stock Market Just a Side Show? Evidence from a Structural Reform

The 2005 split-share reform in China mandated the conversion of previously non-tradable shares into tradable status. The reform was swift and changed investors' ability to trade corporate equities in a US$400 billion market. This paper examines the effects of the 2005 stock market reform on firms' real and financial outcomes. It does so exploiting multiple institutional features of the conversion program. We first examine a small pilot trial conducted at the beginning of the reform, which we are able to replicate using the same data and selection criteria that was used by regulators. We also take advantage of the staggered nature of the larger conversion schedule, whereby over a thousand firms converted their outstanding shares at different times within a pre-specified window. These various wrinkles produce counterfactuals against which to gauge the economic effects of secondary equity trading. Using a time-varying treatment estimation approach, we identify increases in corporate profitability, investment, value, and productivity as pre-existing shares were allowed to trade in organized exchanges. We also identify changes in firms' propensity to issue new shares, pay dividends, and engage in merger deals. Our findings provide new insights on the role of stock markets in shaping corporate behavior and on the impact of regulation on economic growth.

Stock Prices in a Speculative Market: The Chinese Split-Share Reform

In 2005-2006 China reformed its stock market by eliminating non-tradable shares. The regulator set general guidelines and then assigned responsibility for implementation to each company. We derive relations that should have been followed by the prices of stocks and exploit a company-level data set to compare the actual and the theoretical price reactions. We find evidence for abnormal returns both before the beginning of the reform and during the reform. Cross-sectionally, abnormal returns are associated mainly with turnover and compensation. This shows that in a speculative market, investors do not properly react to unambiguous corporate actions.

Stock Prices in a Speculative Market: The Chinese Split-Share Reform

In 2005-2006 China reformed its stock market by eliminating non-tradable shares. The regulator set general guidelines and then assigned responsibility for implementation to each company. We derive relations that should have been followed by the prices of stocks and exploit a company-level data set to compare the actual and the theoretical price reactions. We find evidence for abnormal returns both before the beginning of the reform and during the reform. Cross-sectionally, abnormal returns are associated mainly with turnover and compensation. This shows that in a speculative market, investors do not properly react to unambiguous corporate actions.

Introducing Demutualization and Listing as a Mean to Improve the Management of Chinese Stock Exchanges

China is attracting a lot of attention from the rest of the world for a very good reason. There is much talk all around, discussing about the potential of this far eastern dragon, the likely impacts she will have on the world economy. Undeniably, China is the fastest growing economy on the planet, achieving more than 7 percent GDP growth since 1991. It seems like there is no stopping this giant. But if the picture is all so rosy, what is causing the reluctance of institutional investors from pouring their money into the Chinese exchanges? What are the factors that are constraining China's growth? And how will the solutions to these problems bring about greater benefits for the people in China and the rest of the world? The fundamental problem with the exchanges lies with the issue of corporate governance. There are tons of negative publicity about insider trading, related party transaction and asset stripping by listed companies in the Chinese media, which has greatly impacted investors' confidence. Moreover the existence of non-tradable shares, accounting for more than 60% of all the shares issued on the exchanges has been the greatest impediment to the development of China's equity market. Traditionally, owners of non-tradable shares do not have a chance to realize the value of their shares in the market. As a result, many will abuse their executive power and participate in activities or awarding contracts that will lead to their personal monetary gains. Currently the authorities are involved in a series of shares reforms to rectify the situation. The process of share reforms will indeed bring about improvements to the existing split share structure of most listed companies. However to fully alleviate the lack of corporate governance in the exchanges, implementing the split share reform is not an adequate measure, because the exchanges will still lack the motivation to closely monitor the listed companies. Hence we propose that the two stock exchanges, after going through a successful reform, to go for demutualization follow by listing on the Hong Kong Stock Exchange. The listing act will not only bring about better corporate governance to the Chinese exchanges thereby increasing foreign investors' confidence, it will also fuel the growth of other local financial institutions, entice the public to take out their savings to invest, the exchanges can have more money to invest in high-tech infrastructure, improve service quality of investor relations and more incentive for the Chinese government to lift the capital control etc. The benefits are plentiful but most importantly it will create a more even distribution of income, thereby relieving the poverty pressure and increase the living standards of the majority of Chinese citizens. To evaluate the benefits that a possible demutualization and listing of the Chinese stock exchanges will be the main angle in this paper. It will also seek to give a future outlook of what can be expected after the demutualization and listing take place, and how it will impact the world economy as a whole and the benefits which it will bring for the Chinese communities. Maybe till then, we can see the dragon of the Far East unleash the fullest potential and establishing itself as the economic power house of the world.