Split Share Structure Reform Research Articles

Split-share structure reform and the underpricing of Chinese initial public offerings

ABSTRACTThis paper analyses whether the extreme underpricing of initial public offerings (IPOs) in China has been alleviated by the split-share structure reform in 2005. As an external policy shock to IPO firms, this Reform was designed to convert non-tradable shares into tradable shares, with the potentials to restore the distorted supply–demand relationship of newly issued shares and reduce the information asymmetry in Chinese stock market. Analysing a sample of IPOs in China from 2000 to 2011, we find that the split-share structure reform significantly reduced the magnitude of IPO underpricing since 2005. It had different impacts on the IPO shares issued by state-owned enterprise (SOEs) and non-SOEs. While IPO shares issued by SOEs and non-SOEs had similar underpricing rates before the Reform, non-SOE IPOs show lower underpricing than those of SOEs after the Reform. Furthermore, compared with IPOs issued by SOEs controlled by the central government, those issued by local governments controlled SOEs are more underpriced after the Reform.

Impact of split share structure reform on capital structures: empirical evidence from China’s listed companies

ABSTRACTAn econometric model based on a natural experiment and the difference-in-differences method is introduced to empirically investigate the impact of split share structure reform on capital structures. A total of 1026 listed companies in Chinese A-share during 2001–2011 are used as the sample for the research and interest-bearing debt ratios (BDRs) are taken as a representative indicator for capital structures. The theoretical and empirical analysis indicates that both market expansion effect and corporate governance effect caused by the split share structure reform are associated with an increase in BDR. As far as the timeliness is concerned, the effects of split share structure reform on capital structures will last 3–4 years.

Dynamic relation of Chinese stock price-volume pre- and post- the Split Share Structure Reform

Purpose – The purpose of this paper is to identify the bull and bear regimes in Chinese stock market and empirically analyze the dynamic relation of Chinese stock price-volume pre- and post- the Split Share Structure Reform. Design/methodology/approach – The authors investigate the price-volume relationship in the Chinese stock market before and after the Split Share Structure Reform using Shanghai Composite Index daily data from July 1994 to April 2013. Using a two-state Markov-switching autoregressive model and a modified two-state Markov-switching vector autoregression model, this study identifies bull or bear market and also examine the existence of regime-dependent Granger causality. Findings – Using a two-state Markov-switching autoregressive model, the authors detect structural changes in the market volatility due to the reform, and find evidence of a positive rather than an asymmetric price-volume contemporaneous correlation. There is a strong dynamic Granger causal relation from stock returns to trading volume before and after the reform regardless of the market conditions, but the causal effects of volume on returns are only seen in the bear markets before the reform. The model is robust when using different stock indices and time periods. Originality/value – The work is different from previous studies in the following aspects: most of the existing empirical literature focus on the well-developed economies, but our interest lies in the emerging Chinese market that has witnessed rapid growth in the past decade; in contrast to many works in the literature that examine the price-volume relationship during one market condition, the authors compare the relationship in a bull market with that in a bear market, using a two-state MS-AR model; the authors also employ a modified two-state Markov-switching vector autoregression model to examine the existence of regime-dependent Granger causality; as the most massive systematic reform for the Chinese stock market since its inception in 2005, the Split Share Structure Reform has a profound impact on the Chinese stock market, thus it is of vital importance to explore its effects on both the price-volume relationship and the market structure.

The Effects of China's Split-Share Reform on Firmss Capital Structure Choice

The Split share Structure Reform in year 2005-2006 raises the curtain for China's secondary privatization. It mitigates the agency conflicts between controlling shareholders and minority shareholders and, thus, brings substantial changes to China’s financing behaviors. This paper aims to examine its impact on firms’ capital structure decisions by applying a variety of trade-off and pecking order models. Using data from 1,176 non-financial Chinese listed firms during the period from 2000 to 2012, we present empirical evidence indicating that: firstly, equity tracks the financing deficit better than debt in Chinese firms, which is not consistent with the pecking order theory. This phenomenon is more prominent after year 2006 as the shares reform increases the trading activities in the secondary stock market and thus alleviates the asymmetric information problems. Secondly, the partial adjustment model suggests that Chinese firms have an optimal leverage ratio and they adjust below-target leverage ratios faster than above-target leverage ratios after the implement of the shares structure reform although they make a symmetric adjustment towards the target leverage ratio before year 2007. The implication is that the share-split structure reform reduces the agency costs and costs of upward leverage adjustment, leading to a faster target reversion for firms with below-target leverage ratio but not for those with above-target leverage ratio. Thirdly, the error correction model reveals that before the reform Chinese firms make dynamic adjustment towards target leverage at an asymmetric rate, with stronger and faster response to the changes in target leverage than to past divergence from long-run target leverage ratio. In the post-reform period, however, Chinese firms have made a symmetric adjustment towards the desired leverage as they correct the divergence of their actual leverage ratios from the long-run target level at a faster speed while they do not significantly speed up their response to the short-run target leverage changes. All these results further support the applicability of dynamic target adjustment models.

Determinants of debt across sectors: Evidence from Chinese a-share listed firms

Almost all studies carried out so far in China regarding debt examinations do not recognize difference among business sectors. China completed the second split share structure reform of listed firms by the end of 2007, which converted 97% non-tradable shares into tradable shares. However, there has been no study conducted to analyze whether determinants of debt have changed since the reform. Therefore, this study aims to find determinants of debt of listed firms in China by analyzing data after the completion of reform across sectors. Data sample used in this study includes all A-share listed firms in China from 2008 to 2012. After deleting missing values, there are in total 547 firms with 2,735 observations, which are taken as the initial full data sample. The method employed by the study is a panel data model, because it has the advantage of taking both cross-section and time series into consideration. In addition, a Hausman test is employed to identify whether a model with fixed effects or random effects should be used for analysis. The main findings are: (1) Total debt is mainly dominated by short-term debt, while long-term debt is lowly financed. During 2008 - 2012, total debt as well as long-term debts increase, but short-term debt decreases; (2) Determinants have different effects on long-term and short-term debts; (3) The effects of determinants are different across different sectors, indicating that specific sectorial factors are at work; (4) The debt decision tends to follow the static trade-off theory with consideration for effects of non-debt tax shield and profits. In general, both long-term and short-term debts are affected positively by profits at different levels. Firm size is the most important determinant and is positively related to long-term debt, while non-debt tax shield contributes negatively to short-term debt. This paper presents an in-depth understanding of debt decision in listed firms in China using a joint model to test the interaction between employee productivity and debt. It, therefore, provides a new perspective on investigations of debt decisions of firms across sectors.

Improved corporate governance and Chinese seasoned equity offering announcement effects

AbstractCorporate governance and thus overall investor protection in China improved after the Split Share Structure Reform and the release of the new company law in 2005. This study examines the impact of improved corporate governance and investor protection on the market's reaction to seasoned equity offering (SEO) announcements in China. The market reacts to post‐2005 SEOs positively, while it reacts to pre‐2005 SEOs negatively. The different market reactions are attributed to the market's different perceptions of firms' intentions behind SEO decisions – that is, investors are more optimistic and have more trust in SEO issuers when they believe they are better protected.

Financial development and the cost of equity capital: Evidence from China

This study examines the relation between province-level financial development and the cost of equity in China. Our main findings are that (1) stock market development reduces the cost of equity in general, but the effect diminishes significantly in state-owned enterprises (SOEs) and firms with high growth potential or innovation intensity and (2) banking development only marginally lowers the cost of equity, but the effect is stronger in non-SOEs. Further analysis reveals that stock market development substitutes for such institutional factors as accounting quality, law enforcement, stock market integration and the split-share structure reform in lowering the cost of equity. We also find that lack of banking competition and banking marketization and under-development of the non-state economy partially account for the weak effect of banking development on the cost of equity.

Misvaluation comovement, market efficiency and the cross-section of stock returns: Evidence from China

In this study, we examine the relation between stock misvaluation and expected returns in China's A-share market. We measure individual stocks’ misvaluation based on their pricing deviation from fundamental values, following Rhodes-Kropf et al. (2005. J. Finan. Econ. 77 (3), 561) and Chang et al. (2013. J. Bank. Finance, forthcoming), and find that the measure has strong and robust return predictive power in the Chinese market. We further form a misvaluation factor and find that misvaluation comovement and systematic misvaluation exist in the Chinese market. A comparison of our results with those of Chang et al. (2013. J. Bank. Finance, forthcoming) reveals that the misvaluation effect is much stronger in the Chinese market than in the U.S market. This evidence is consistent with the notion that the Chinese market is much less efficient than the U.S. market. Finally, we show that the return predictive power of misvaluation has weakened since China launched its split-share structure reform in 2005, which could result from the fact that the reform helps to promote market efficiency.

The impact of corporate governance and ownership structure reforms on earnings quality in China

Purpose – The purpose of this paper is to investigate the effect of corporate governance and ownership structures on earnings quality in China both prior and subsequent to two important corporate reforms: the code of corporate governance (CCG) in 2002 and the split share structure reform (SSR) in 2005. Design/methodology/approach – This study utilises informativeness of earnings (earnings response coefficient), conditional accounting conservatism and managerial discretionary accruals to assess earnings quality using 12,267 firm-year observations over 11 years from 2000 to 2010. Further, two dummy variables for measuring the changes of CCG and SSR are employed to estimate the effects of CCG and SSR reforms on earnings quality via OLS regression. Findings – This study finds that the promulgation of the CCG in 2002 has had a positive impact, but the SSR reform in 2005 has had little effect on listed firms’ earnings quality in China. These results hold good after controlling for a number of ownership, governance and other variables and estimating models with multiple measures of earnings’ quality. Research limitations/implications – Future research could focus on how western style corporate governance mechanisms have been constrained by the old management systems and governmental dominated ownership structures in Chinese listed firms. The conclusion is that simply coping Western corporate governance model is not suitable for every country. Practical implications – The results will assist Chinese regulators in improving reporting quality, ownership structure and governance mechanisms in China. The results will help international investors better understand quality of financial information in China. Originality/value – This is the first to our knowledge that addresses the effects of major governance and ownership reforms together on accounting earnings quality and, thus, makes a significant contribution on understanding the effect of regulatory reforms on improving earnings quality. In doing so, it also indirectly assesses the effectiveness of western-style corporate governance mechanisms introduced in China.

IPOOOOOOOOOOO (Split-Share Structure Reform and Earning Management between Pre-IPO and Post-IPO)

Chinese Abstract: PO过程中是否存在向上盈余管理是研究者和政策制定者持久关注的话题，动机和机会是影响IPO过程盈余管理行为的重要因素，本文以股权分置改革为契机检验了制度变迁所导致的决策主体利益函数变化对IPO过程盈余管理行为的影响。研究发现，由于IPO过程严苛的法律监管和高额的法律风险，IPO前向上盈余管理幅度显著低于IPO后的盈余管理幅度，上述现象在股权分置改革之后更为明显，而这种现象主要存在于获得实质性流通权的民营上市公司当中。这意味着，股权分置改革改变了大股东的盈余管理动机和盈余管理行为模型，未来监管的重点应该后置，需要特别关注最终控制人股票限售期期满之时的会计质量。English Abstract: Whether earning management exists during IPO is one of hot topics for researchers and supervisors. This paper studies the impact of split-share structure reform on the earning management between pre-IPO and post-IPO. We find that the earning management during pre-IPO is lower than that of post-IPO and it is more salient after split-share structure reform. And we find the relationship between split-share structure reform and earning management only exists in private companies. These findings mean that the focus of supervision should transform to post-IPO.

Performance Commitments of Controlling Shareholders and Earnings Management

AbstractSince the Split Share Structure Reform took effect in China in 2005, holders of nontradable shares (controlling shareholders) have had to negotiate with holders of tradable shares (minority shareholders) to gain the liquidity right. In a typical deal reached, the controlling shareholder agrees to pay share compensation to minority shareholders and, in many cases, also pledges to meet a specific firm performance target (performance commitments). Using this reform setting, we examine the impact of performance commitments on earnings management behavior, and find the following results. First, less profitable firms have greater incentives to make performance commitments that help to reduce the share compensation that controlling shareholders have to pay. Second, firms entering into such commitments engage in earnings management to meet the promised performance target when actual performance falls short, and firms facing greater default costs tend to manage earnings more aggressively. Third, depending on the performance metric stipulated in the commitment contract, firms employ varying methods to manage earnings. We also find that firms that rely on earnings management to meet their performance targets display inferior performance in the postcommitment years relative to firms that do not. Overall, our evidence is consistent with performance commitment contracts (with costly defaults) between a firm's controlling and minority shareholders causing incentives for earnings management.

Blockholder Exit Threats in the Presence of Private Benefits of Control: A Quasi-Experiment from Chinaas Split-Share Structure Reform

Using the Split-Share Structure Reform (SSSR) in China as a quasi-experiment, we examine whether and how non-managerial blockholder exit threats discipline managers when private benefits of control (PBC) are prevalent. SSSR removed the selling restrictions on previously-dominant non-tradable shares, thereby providing a large, exogenous, and permanent shock to the cost for non-managerial blockholders to exit. However, because such exit potentially reduces non-managerial blockholders’ threats to control rights and managerial blockholders could benefit from the exit, it is ex ante uncertain whether exit threats would be effective in this setting. Using a difference-in-differences design, we find that the shock to exit threats, on average, improves firms’ operating performance. Specifically, we find that firms whose non-managerial blockholders experience a larger exit-threat increase have a greater improvement in performance than those whose non-managerial blockholders experience no or a smaller increase. Within the treatment sample, better performance is observed for firms whose managers’ wealth is more closely tied to stock prices. Our results are robust to numerous controls, different specifications, and alternative measures of operating performance. The findings suggest that exit threats discipline managers even when PBC are prevalent. Further cross-sectional analyses show that the governance effect of exit threats is weaker when PBC are a stronger concern. In particular, the governance effect for firms headquartered in coastal provinces and with less concentrated ownership (indicators for lower PBC) is significantly stronger than that for firms headquartered in inland provinces and with more concentrated ownership. Finally, we identify improvement in investment efficiency and reduction in agency costs as two potential channels through which the shock affects operating performance, and we show that the changes in performance occur around the time when the expectation of a future increase in blockholders’ exit threats is formed.

Dividend Policy, Corporate Governance and Stock Liquidity

This paper examines the effect of corporate governance and stock liquidity on corporate payout policy in the context of the split-share structure reform initiated in 2005 in China. In this reform, non-tradable shares were converted into tradable shares compulsorily. The reform removed a liquidity constraint; meanwhile it facilitated a better alignment of the interests of the controlling shareholders with those of the outside investors. These lead to significant improvements in firms’ liquidity and governance. We find that on average, cash dividends decrease significantly after the reform. The reduction in payouts is more pronounced for firms with higher growth rates and liquidity. In terms of cash dividends, a larger decline in the post-reform periods is observed in firms that are controlled by state shareholders.

The Real Effects of Privatization: Evidence from Chinaas Split Share Structure Reform

The Real Effects of Privatization: Evidence from Chinaas Split Share Structure Reform

Tradable Block Ownership, Liquidity and Threat of Exit

Large shareholders may affect managerial decisions through the threat of selling their holdings and thereby negatively influencing price. The split-share structure of Chinese corporate ownership imposes restrictions on ownership and shares trading. Using these institutional features, we test the hypothesis that the presence of a blockholder who is potentially able to trade based on private information may help discipline management and improve information disclosures, thereby improving stock liquidity. Our results show that the exit threat is closely associated with shares’ tradability and to the extent that tradable (non-tradable) blockholders can discipline management through exit threats, they exert a positive (negative) liquidity effect through both real and information friction channels. These results are robust to the possible confounding effect of liquidity-induced tradable block ownership, as shown by the difference-in-differences analysis based on the split-share structure reform, which results in an exogenous shock to the level of tradable block shares. There is evidence that the liquidity effect of tradable block ownership displays an inverted U-shape relationship, implying that exit costs rise when more tradable shares are acquired.

CEO Accountability for Corporate Fraud: Evidence from the Split Share Structure Reform in China

We use institutional-related theories and a unique natural experiment that enables an exogenous test of the influence of controlling shareholders on managerial accountability to corporate fraud. In China, prior to the Split Share Structure Reform (SSSR), state shareholders held restricted shares that could not be traded. This restriction mitigated state-owned enterprise controlling shareholders’ incentives to monitor managers. The data examined show the SSSR strengthens incentives of state-owned enterprise controlling shareholders to replace fraudulent management. Our findings support the view that economic incentives are important to promote corporate governance and deter fraud.

CEO Accountability for Corporate Fraud: The Role of Controlling Shareholders and Institutional Reform in China

We use institutional-related theories and a unique natural experiment that enables an exogenous test of the influence of controlling shareholders on managerial accountability to corporate fraud. In China, prior to the Split Share Structure Reform (SSSR), state shareholders held restricted shares that could not be traded. This restriction mitigated state-owned enterprise controlling shareholders’ incentives to monitor managers. The data examined show the SSSR strengthens incentives of state-owned enterprise controlling shareholders to replace fraudulent management. Our findings support the view that economic incentives are important to promote corporate governance and deter fraud.

Controlling shareholders’ incentives and executive pay-for-performance sensitivity: Evidence from the split share structure reform in China

Using the split share structure reform in China as a natural experiment, we study how changes in controlling shareholder incentive affect the pay-for-performance sensitivity. The reform converts the shares owned by controlling shareholders from non-tradable to tradable shares. The removal of such market friction allows for a better alignment of interests between controlling and minority shareholders, which gives managers more incentives to improve corporate performance. We find that the pay-for-performance sensitivity improves greatly after the reform. Changes in the pay-for-performance sensitivity are also associated with firm ownership structure, the level of agency conflicts and governance quality. Given that firms with controlling shareholders are the dominant form of business organization in many countries around the world, our results have important implications in that they show that a better alignment between controlling and minority shareholders’ incentives has a significant effect on executive compensation.

Foreign institutional investors and corporate governance in emerging markets: Evidence of a split-share structure reform in China

Using data on China's split-share structure reform that floats non-tradable shares, we find that Qualified Foreign Institutional Investors (QFIIs) have greater influence over the controlling state shareholders than local mutual funds. QFIIs are less prone to political pressure and are more likely to participate in arm's-length negotiation and monitoring in state-controlled companies. The presence of QFII ownership shortens the duration of the reform and increases the compensation to minority tradable shareholders. Unlike local mutual funds, the positive relationship between state ownership and the compensation to tradable shareholders increases with the presence of QFII ownership. Furthermore, QFIIs increase the likelihood of revision in reform proposals among state-controlled companies. Domestic mutual funds seem to make earnest negotiations in non-state-controlled companies in the absence of political pressure. Evidence suggests that involving foreign institutional investors in corporate governance practices can significantly reduce expropriation by controlling shareholders in emerging markets.

The determinants behind Chinese companies’ incremental equity issue decisions

This paper studies the determinants behind Chinese companies’ decisions to make seasoned equity offerings (SEO). Probit regressions are employed and a Monte Carlo simulation method is used to confirm the non-existence of the spurious correlation problem found in traditional models of capital structure. Evidence is found to confirm the privilege of state-controlled enterprises to access equity. A corporate governance indicator based on the completion of the Split Share Structure Reform is also introduced. However, no evidence to support the importance of corporate governance is found. The results of this study imply that in a country where the state dominates the intermediation of capital, investors and thus companies are less sensitive to the quality of corporate governance. Different factors have been observed to affect Chinese firms’ SEO decisions prior to and post the Split Share Structure Reform. The influence from the state has also been weakened after the reform, particularly after the global financial crisis.