Split Share Structure Reform Research Articles

Corporate structure, partial privatization, and wage inequality: Evidence from China's split share structure reform

This paper examines the effects of privatizing China's state-owned enterprises (SOEs) on wage distribution and the welfare of the economy. Privatizing profitable SOEs can narrow wage inequality and improve welfare, and it is however accompanied by a business dynamism effect that can widen the skilled-unskilled wage gap. Using China's split share structure reform in 2005 as a quasi-natural experiment, we empirically demonstrate for profitable SOEs a positive relationship between partial privatization and wage gap. Our findings are consistent with the plan to wind down unprofitable SOEs that would not survive without government subsidies.

Foreign institutional investors’ certification and domestic minority shareholders’ mistrust

AbstractUsing hand‐collected data from China's split share structure reform (SSSR) program, we show that foreign institutional investors’ certification mitigates domestic minority shareholders’ mistrust of controlling shareholders’ reform plans and facilitates the implementation of the SSSR. Domestic minority shareholders cast fewer dissenting votes, complete the SSSR more quickly but with lower compensation, and achieve higher stock return reactions in reforming firms with higher foreign institutional ownership. Foreign institutional investors’ prestige is a key factor in aligning domestic minority shareholders toward seeking long‐term payoffs. Our work reveals the positive role of foreign institutional investors’ certification in a salient reform of corporate governance.

Are firms more concerned about analysts’ earnings forecasts after the split-share structure reform? Evidence from China

PurposeThis study aims to examine whether Chinese firms increase their concerns about analysts’ earnings forecasts following the split-share structure reform (SSR) in 2005, which removed trading restrictions on approximately 70% of the shares of listed firms.Design/methodology/approachUsing data from 2002 to 2019, the authors empirically test the association between meeting or beating analysts’ earnings expectations and the implementation of SSR.FindingsThe authors find that firms are more inclined to meet analysts’ earnings expectations after the introduction of SSR. Further analysis shows that firms guide analysts to walk their forecasts down by manipulating third-quarter earnings, suggesting enhanced value relevance between analysts’ forecasts and third-quarter earnings management in the postreform period.Practical implicationsThe findings reveal an undesirable side effect of SSR and suggest that policymakers and regulators should consider and carefully manage the complex relationships between firms and analysts.Originality/valueIn contrast to prior studies that predominantly focus on the positive effects of the reform, this study reveals the side effects of SSR and provides new evidence on the mechanisms of meeting or beating analysts’ earnings expectations.

Replicating and Digesting Anomalies in the Chinese A-Share Market

We replicate 469 anomaly variables similar to those studied by Hou et al. (2020) using Chinese A-share data and a reliable testing procedure with mainboard breakpoints and value-weighted returns. We find that 83.37% of the anomaly variables do not generate significant high-minus-low quintile raw return spreads. Further adjusting risk increases the failure rate slightly to 84.22% based on CAPM alphas and 86.99% based on Fama–French three-factor alphas. We show that the conventional procedure using all A-share breakpoints with equal-weighted returns for the anomaly test is indeed problematic as it assigns too much weight to microcaps and has a very limited investment capacity. The CH3-factor, CH4-factor, and q-factor models show the best performance over the whole sample period. The q-factor model is the best performer in the post-2007 subsample period after significant improvements occurred in China’s financial market environment, such as the completion of the split-share structure reform and the implementation of new accounting standards conforming to the International Financial Reporting Standards. The non–state-owned enterprise subsample in the post-2007 period is a cleaner sample in which the CH4-factor and q-factor models are the best performers. This paper was accepted by Lukas Schmid, finance. Funding: Z. Li acknowledges financial support from the National Natural Science Foundation of China [Grant 72103043] and the Fundamental Research Funds for the Central Universities in UIBE [Grants 19QN01 and 22PY053-72103043]. L. X. Liu acknowledges financial support from the National Natural Science Foundation of China [Grants 71872006 and 72273006]. L. X. Liu and X. Liu acknowledge financial support from the Guanghua Thought Leadership Platform of Peking University. K. C. J. Wei acknowledges partial financial support from the Research Grants Council of the Hong Kong Special Administrative Region, China [Grant 15507320]. The authors acknowledge financial support from the Guanghua School of Management, Peking University; the School of Banking and Finance, University of International Business and Economics; and the Non-PAIR Research Centre “Research Centre for Quantitative Finance” at Hong Kong Polytechnic University. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4904 .

Auditors’ response to earnings management after split-share structure reform in China

PurposeThis study aims to investigate whether and how auditors responded to the documented increases in earnings management after split-share structure reform (SSSR) in China, as manifested in auditors’ propensity to issue modified audit opinions (MAOs) after the SSSR. This study further investigates how client importance and auditor size influence auditors’ response to earnings management after the SSSR.Design/methodology/approachThis study adopts logit regression models to investigate auditors’ propensity to issue MAOs to their clients that appear to manage earnings after the SSSR. Initially, including all Chinese publicly listed firms from the CSMAR database, the sample for final analyses consists of 21,904 firm-year observations for 1,290 unique listed firms during the period 2001–2020. The sample period surrounds the implementation of the SSSR, which started in 2005, allowing the examination of auditors’ propensity to issue MAOs after vis-à-vis before the SSSR.FindingsThe authors find that non-Big10 auditors in China were less likely to issue MAOs to their economically important clients who appear to manage earnings after SSSR. However, in the years of non-tradeable shares being released to the markets, both Big10 and non-Big10 auditors were less likely to issue MAOs to their economically important clients who appear to manage earnings. The findings suggest that auditors may have compromised auditor independence in response to earnings management after the SSSR, likely due to the pressure from their economically important clients.Originality/valueThis paper contributes to the literature, specifically the practice and theory in auditing, by shedding light on ever-changing auditors’ reporting behaviour, especially with regard to auditor independence. It also adds to the growing body of literature on the impact of institutional changes on auditing practices worldwide. The findings of this study further suggest that the recently documented declining demand for high-quality audits after the SSSR may be motivated by the clients’ intention to manage earnings after the SSSR.

English

In China, the split-share structure reform (SSR) has many benefits in helping decrease agency costs and normalise the stock markets. This paper explores the specific effects of this policy on firms’ signalling behaviour, audit fee charges and the meeting or beating earnings expectation (MBE) strategy through empirical research into the relations of these three subjects, combined with a cross-sectional analysis of their deeper influences. The outcomes of this study demonstrate that after the SSR, firms have more incentive to convey inside information and signal earnings, the audit fee charged for firms is reduced and firms are more willing to meet earnings expectations.   Key words: Split-share structure reform; earnings signalling; audit fees; earnings surprise; management disclosure.

Stock liquidity and investment efficiency: Evidence from the split-share structure reform in China

Using China’s split-share structure reform, we examined the effect of stock liquidity on investment efficiency. We found that enhanced stock liquidity results in more efficient investments and the effect is much more pronounced for under-investing firms than for over-investing firms. Additionally, we found that an increase in institutional ownership and price efficiency generated by a change in stock liquidity is positively associated with a reduction in under-investment. Thus, these findings suggest that under-investing firms with liquid stocks have more informed investors and face greater pressure to select an optimal investment level in the post-reform period.

The Role of Privatisation in Sustaining Auditor Independence: Evidence from the Developing Markets

This paper investigates the role of structural ownership reforms in sustaining auditor independence through split-share structure reform (SSSR). Studying a sample of 1826 Chinese listed firms over the SSSR period in China, the results showed that auditor independence sustainability was less pronounced in local state-owned enterprises (LSOEs) compared with non-state-owned Enterprises (NSOEs). Nevertheless, after the SSSR, there is a significant enhancement in sustaining auditor independence. In particular, auditor independence sustainability is pronounced by providing an unqualified audit opinion, including an ‘emphasis of matter paragraph’ instead of issuing a modified audit opinion. This study contributes to the literature in two ways. First, it gives an empirical investigation into auditor independence sustainability efforts by the Chinese government through the SSSR. Second, it helps regulators and policy-makers in China and other emerging markets in evaluating the SSSR efforts to improve auditor independence.

Ultimate government control and stock price crash risk: Evidence from China

Using data of Chinese firms over 2004–2018, we find that firms controlled by government entities, particularly central government entities, are less prone to stock price crashes, as compared with privately controlled firms. The effect is robust to alternative estimation approaches and moderated by the Split-share Structure Reform and the anti-corruption campaign. The results attest to the incentive alignment view that controlling and minority shareholders align their interests and stock prices perform well. Further, we find that government-controlled firms exhibit less financial opacity, undertake less risky investments, and appoint myopic CEOs, through which stock price crash risk is diminished.

Institutional investors and earnings management associated with controlling shareholders' promises: Evidence from the split share structure reform in China

We examine the effectiveness of institutional investors in constraining aggressive earnings management induced by strong contractual incentives. To this end we focus on the consequences of earnings-related promises (covenants) negotiated between corporate controlling shareholders and minority shareholders during China’s split-share structure reform, wherein failure to achieve profit benchmarks had the potential to transfer significant wealth from controlling to minority shareholders. Our initial analysis provides evidence that profit-promised firm-years are, on average, associated with income-increasing earnings management, and that this association is stronger for: (i) firm-years in which the profit-promise was satisfied, and (ii) firm-years in which proxies for the level of unmanaged earnings suggest that earnings management was needed to satisfy the promise. However, such benchmark-beating behavior is weaker for firms with higher levels of institutional ownership. Further analysis documents that the exit threat of institutional shareholders can discipline earnings management associated with profit promises. We also show that the effect of institutional shareholders in reducing earnings management associated with profit promises is greater for domestic mutual funds and for privately controlled firms. Interestingly, our evidence suggests that institutional investors only play an effective monitoring role over earnings management when their incentives are strongly aligned with those of other minority owners. In other cases, our evidence suggests that these investors may exacerbate the level of earnings management.

Ownership Characteristics and Financial Performance: Evidence from Chinese Split-Share Structure Reform

This paper investigates the relationship between two characteristics of corporate governance (concentrated and state ownership) and firm financial performance by bringing new and extensive evidence from an emerging market. Further, this study examines the impact of the recent stock split reform in China on the corporate ownership characteristics–firm performance relationship. The final sample of this study is comprised of 234 firms with 2340 annual observation values. The study hypotheses are examined using regression analysis of panel data. We found that concentrated ownership is positively and significantly related to firm performance. However, state ownership has a significant negative impact on firm performance. Further, we observed that the stock split reform has a substantial and positive effect on the ownership–corporate financial performance relationship. In particular, the positive relationship between ownership concentration and firm performance has increased following the split-share structure reform. The negative relationship between state ownership and corporate financial performance has been mitigated following the split-share structure reform. We contribute to the existing literature on corporate governance by investigating the ownership–corporate financial performance relationship in a unique research setting based on the impact of an exogenous regulatory change, namely, the split-share structure reform in China. The study presents implications for regulators, investors, and researchers interested in examining developing markets such as China. Our results imply that the institutional reform of the Chinese stock market has benefitted investors through enhancing corporate financial performance. The findings suggest that the reform of the Chinese stock market has significantly shaped the impact of ownership structure on corporate financial performance in a valuable way for effective capital allocation. Thus, collectively, the split-share structure reform enhances the quality of corporate governance, which is pivotal to the growth of the country’s economy. This, in turn, has policy implications for other emerging economies.

The Impact of China's Recent Structural Reforms on Listed Firms' Auditor Choice

This paper studies the tendency towards developing China's national accounting industry against the international Big 4 accounting firms. Studying a Chinese sample from 2003 to 2014, covering the recent structural reforms (i.e., the Split-share Structure Reform (SSSR) in 2005 and the announcement of Document 56 in 2009) the paper concludes that such reforms increased the tendency to hire higher quality national audit firms compared with the international Big 4 audit firms and other small audit firms. This study also highlights the role of market development in improving the likelihood of hiring high quality auditors, and how it counteracts the state influence over the firm's auditor choice. By splitting high quality accounting firms into: the international Big 4 and the Chinese national Big 6, this paper extends the literature on political economy and auditor choice and explains how China is developing its national accounting industry through issuing state policies and restructuring the accounting industry.

China’s secondary privatization and corporate investment efficiency

This study exploits China’s secondary privatization initiated by the Split-Share Structure Reform as an identification strategy to investigate whether and how ownership type affects corporate investment efficiency. We show that compared with the always state-owned enterprises, the investment efficiency of privatized firms improves significantly after privatization. We further find that the alleviation of government intervention and agency problems are channels through which privatization improves corporate investment efficiency. Moreover, privatization mitigates over-investment through the financing channel. The efficiency-improving effect is more pronounced in industries with higher market competition, and regions that are more market-oriented.

Mood Beta, Sentiment and Stock Returns in China

We examine the cross-sectional seasonality of stock excess returns in China. We find that stocks’ historical excess returns are positively related to their future excess returns under a congruent-mood period and negatively associated with their future excess returns under a noncongruent-mood period. Besides, stocks with larger mood beta tend to outperform during mood periods, and this impact is still significant after differentiating companies. Moreover, consistent with our hypotheses, mood beta has stronger explanatory power after China’s unique Split-Share Structure Reform and RMB Exchange Rate Reform. Finally, mood beta has stronger explanatory power compared to sentiment beta during ascending and descending mood months.

Blockholders, tradability and information asymmetry: Evidence from Chinese listed firms

In this paper, we conduct an extensive empirical study on the relationship between block ownership and information asymmetry based on the split-share structure of Chinese corporate ownership. Unlike prior studies, we find that a blockholder with a propensity to trade can reduce information asymmetry. This information asymmetry reduction does not take place through increased information aggregation by tradable blockholders. Rather, credible exit threats by tradable blockholders help reduce information asymmetry through instilling discipline in management and enhancing transparency in information disclosures. We further show that the cost of exit threats by tradable blockholders can explain the different findings from prior studies. These results remain robust to the possible confounding effect of tradable block ownership as shown by the difference-in-differences analysis of the split-share structure reform, which serves as an exogenous shock to tradable block shares.

Information disclosure ratings and continuing overreaction: Evidence from the Chinese capital market

On the basis of the theory developed by Daniel, Hirshleifer, and Subrahmanyam (DHS) (1998), this study examines the influence of information disclosure rating on continuing overreaction and the role and effects of information disclosure rating in emerging markets. Using a comprehensive sample of firms listed in the Shenzhen Stock Exchange (hereafter, SZSE) from 2001 to 2018, this study finds that a higher information disclosure rating leads to greater continuing overreaction and that increased investor attention, rather than stock liquidity, is the main channel of influence. According to a review of relevant literature, this is the first study to evaluate the association between information disclosure rating and continuing overreaction. After the addition of control variables, use of alternative proxies, and overcoming potential endogeneity problems, a robust conclusion is obtained. Moreover, considering the uniqueness of China’s stock market, tests of the split-share structure reform (SSSR) and state-owned enterprises are conducted. Compared with those of developed countries, China’s information disclosure system is not mature and comprehensive. Therefore, financially illiterate individual investors, when exposed to large amounts of information, are unable to make rational decisions and tend to rely too much on official sources and follow the herd, leading to a more serious continuing overreaction in the market.

Management compensation and corporate governance reform in China

This paper investigates the effect of split-share structure reform on the dynamics between executive compensation and firm performance for Chinese public firms. Using panel data analysis and a dynamic GMM model, it reveals that the split-share structure reform has positive impacts on management compensation and firm performance. The reform results in significant liquidity and control effects on executive compensation shown by increases in market capitalization and decreases in state ownership of the firms. The results generally support the principles of agency theory and confirm the existence of performance-based pay scheme in Chinese public firms. However, evidence also demonstrates that Chinese management compensation practices may emphasize relation-based contracts rather than market-based contracts. This finding implies that government officials or corporate board members may ensure efficient incentives in situations involving weak corporate governance. The findings have important implications for investors, board members, and policy makers who wish to understand the lexicon of political science in emerging markets.

Co-evolution of ownership reform and corporate governance effectiveness in Chinese listed firms

Corporate governance is one of the most widely studied topics in management and business ethics. However, the effectiveness of firms’ corporate governance mechanisms has often been questioned. We adopt an institutional perspective to understand how firms’ corporate governance mechanisms will only be effective when the prevailing institutional context adequately addresses the rights and incentives of controlling shareholders. Taking China’s split-share structure reform in 2005 as a natural experiment, we examine whether shareholder monitoring, board monitoring, executive turnover, and executive compensation can mitigate the risk of organizational distress before and after the reform. Using matched samples of distressed and non-distressed Chinese public-listed firms, we observe that controlling and institutional ownership, executive turnover, and executive compensation reduce the likelihood of organizational distress only after the reform while board monitoring remains ineffective. Our theory and results offer important insights into how the effectiveness of firms’ corporate governance mechanisms co-evolves with prevailing institutional contexts in an emerging economy and how the principal-agent and principal-principal problems are integrally linked.

Mutual fund herding and return comovement in Chinese equities

This paper explores the role mutual fund herding plays on the return comovement in Chinese equities. The results show that mutual fund herding significantly reduces the return comovement among Chinese stocks, providing evidence for the existence of a rational herding behavior by mutual funds. We find that the negative effect of mutual fund herding on return comovement is larger for stocks with low volatility and high mutual fund ownership. We also observe that mutual fund herding has a stronger impact on return comovement after the full-implementation of the Split-Share Structure Reform in China in 2012 which allowed all shares to be traded freely among all market participants.

Liquidity, Ownership Structure and Dividend Policy: Evidence from China’s Split Share Structure Reform

Abstract Since ownership structure has played an increasingly significant role in corporate governance, considerable importance has been attached to the relationship between firm’s corporate ownership structure and its dividend policy. In this study, the Split Share Structure Reform that allowed previously non-tradable shares to be freely tradable in the secondary market and were implemented in batches could be treated as an exogenous shock for stock liquidity and thus a diff-in-diff method could be adopted as the natural experiment for the relationship between ownership structure and dividend policy change due to the stock liquidity increase in Chinese stock market. We find that the average dividend of Chinese-listed firms increased after the reform. Additionally, firms with multi relative controlling shareholders and firms with only minority shareholders experienced a significant increase in dividend while firms with absolutely controlling shareholder suffered a significant dividend reduction. The mechanism for the influence of stock liquidity increase on dividend policy change for firms with above three ownership structures could be explained by the internal fund channel, the agency problem channel and the wealth expropriation channel separately. JEL classification numbers: G18, G32, G35. Keywords: Ownership Structure, Dividend Policy, Liquidity, Split Share Structure Reform.