Research Proposal: Performance of Chinese Listed Companies With Respect to Ownership Structure

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Performance of Chinese Listed Companies With Respect to Ownership Structure

Chinese listed companies have different ownership structures. They can be broadly classified as those majority owned by the state, Sino-foreign joint ventures and private enterprises. The performance of the companies is also influenced by the fact that not all of the shares were freely transferable on the open market. The Chinese government, though, has been allowing these so called "legal person shares" to become formally transferable, a process that implies more liquidity. Although most of these shares remain ultimately controlled by the Chinese government, the presence of these institutional shares is believed to exert a positive effect on firm performance (Stiglitz 2001).

Whether these influences also have an impact on firm performance as reflected by share prices, though, remains unknown, and this gap in the literature forms the focus of the study proposed herein. The research topic will be to study the relationship of Chinese listed state- owned companies before and after the stock reform program. The program was meant to gradually and orderly unlocked and free up "legal person" shares which were non-transferable so that the shares would become freely tradeable on the stock market. In addition, the study will conduct a comparison of the performance of these state-owned companies with respect to market performance by their peers.

2.

OVERVIEW of LITERATURE

The growth of the Chinese stock market during the 1990s was highly impressive, and its performance was all the more noteworthy because of the environment in which this growth took place. For instance, according to Wong (2006), "For more than 30 years after 1949, China was a centrally planned economy in which virtually all enterprises were state owned or collectively owned. Investments were centrally planned and funded by government fiscal grants as well as by loans from the state-owned monobank system as dictated by the government's central credit plan" (2006, p. 389).

This framework began to undergo some profound changes during the late 1980s, though, and a number of enterprise reforms were implemented as part of the larger framework that was being used for China's gradual transition into a market economy (Wong 2006). For example, local governments took the opportunity to experiment with selling shares of collectively owned enterprises to Chinese consumers directly in an effort to generate equity capital, and curbed trading of enterprise shares was followed by over-the-counter trading in various stock exchanges that were better organized but still informal (Wong 2006). This changed as well in 1991, when two stock exchanges were created, the first by the Shanghai municipal government and the second by the Shenzhen municipal government followed formal approval by the Chinese government (Wong 2006).

Moreover, China's 1996 shift from an economy of shortage to one of surplus reduced rent-seeking opportunities for local officials and managers arbitrating between the plan and the market. The good times of diverting some goods from the planned sector to sell at higher market prices to needy consumers, for the benefit of all concerned, were over. Furthermore, local market niches have become unsustainable, despite the best protectionist efforts of the local cadres (Lin 2008). Widespread privatization of town and village enterprises soon ensued, and state-owned enterprises began to cut their losses by discharging workers and experimenting with mergers and other market consolidation options (Lin 2008).Indeed, during the 11-year period between 1992 and 2003, the Chinese market generated a total of 796.79 billion yuan (about U.S.$125.81 billion) of equity capital (Wong 2006). By the end of 2003, the Chinese stock market had more than 70 million investor accounts and 1,287 listed enterprises and (Wong 2006).

After economic reform of nearly two decades that has ushered in sustained double-digit growth unprecedented in Chinese history, the restructuring of state-owned enterprises (SOEs) has become the key to the success of the Chinese economy in the next decade. In contrast to the radical ownership privatization approach widely adopted in Russia and Eastern Europe, China's reform of SOEs started with the market approach. This market-oriented approach posits that if competitive markets are created for products and factors of production, SOEs can be successfully transformed from loss-making cost centers into profitable, return-oriented investment centers without radical changes in ownership structure (Qi et al. 1999).

Although this approach has contributed significantly to the growth of the overall Chinese economy, it has largely failed in enhancing the performance of SOEs, as evidenced by the increasing percentage of SOEs that are operating in the red. Consequently, systematic ownership reform has become the dominant theme behind the two-pronged new initiatives for SOE restructuring. While unprofitable small- and medium-sized SOEs are privatized or merged, large SOEs are converted into shareholding companies with limited liabilities, and a selected few are listed on China's two stock exchanges. Behind these recent strategic moves is the belief that transformed-SOEs can be protected from government interference in their daily operations, clarify their property rights, help them raise new capital, and make the management more accountable for the consequences of its decisions. Improved corporate performance will ensue and the state can benefit through its shareholding in these SOE-transformed companies (Qi et al. 1999).

The performance of SOEs cannot necessarily be improved by setting up shareholding companies alone, though, for a number of reasons including the following:

1. Severe agency problems arising from the separation of ownership and control continue to exist in these SOE-transformed companies if the state remains the controlling shareholder. As the state and its representatives have inadequate resources and expertise in monitoring and disciplining the management, the conflict of interests between the state and the management persists. In fact, the management enjoys more autonomy after corporatization and effectively controls shares owned by the state.

2. It is not always clear that the objective function of the state and its representatives is to maximize shareholder value. For example, the state may want to keep redundant workers on the payroll of the SOEs and SOE-transformed companies to preserve social stability, even though such a policy renders them less profitable.

3. It is well-known that diffused shareholders are not adequately motivated to monitor management decisions closely because of the free-rider phenomenon. Therefore, the performance of SOE-transformed firms may be affected by their ownership structure (Qi et al. 1999).

Across the board, the Chinese experiment with shareholding has exceeded even the liberal model recommended by the World Bank (Cao 2000). According to Wong (2006), the Chinese State Council promulgated regulatory guidance in May 1992 that categorized the shares of a shareholding enterprise into three types:

1. State and legal person shares (these are owned either directly or indirectly by the state and which cannot be traded freely on the stock exchanges but can be transferred only with administrative approval);

2. a-shares (these are yuan-denominated and are available for trading by domestic private shareholders on the stock exchanges); and,

3. B-shares (these are available for trading by foreign investors in foreign currencies on the stock exchanges).

This regulation effectively codified an interesting aspect of China's stock market in that there are three distinct markets for the stocks of a listed enterprise: (a) the one-way transfer market for state-owned shares, (b) the a-shares market for domestic private shareholders, and (c) the B-shares market for foreign investors (Wong 2006). In this regard, Qi, Wu and Zhang (1999) report that, "Equity ownership in a listed Chinese firm can have as many as five different classes: state-owned shares, legal-person shares, tradable a-shares, employee shares, and shares only available to foreign investors, a phenomenon that is unique to the Chinese equity market" (p. 1). With the reform proceeding, the foreign and private sector of the economy developed greatly. As a result, diversified forms of ownership and diversified forms of operation have come into existence. In recent years, realizing the disadvantage of state-owned enterprises in competition, the government took different measures in reforming state-owned enterprises. Thousands of state-owned enterprises have become stock companies. Foreign investors are even allowed to purchase small-scale state-owned enterprises, after state enterprises were structured into stock companies (Wang, 2000, p. 80).

Laws and regulations are also enacted for enterprises to "corporatize" into entities established on the basis of a stock ownership system. At the national level, the State Commission for Restructuring the Economic System (the Commission) and other relevant government departments jointly issued the Share Enterprise Trial Measures (the Measures) on 15 May 1992. Pursuant to the Measures, the Commission issued regulations called the Opinion on Standards for Companies Limited by Shares (Opinion), setting out guidelines for establishing stock companies. It is not clear why the Opinion is called an "opinion" rather than "regulations," and whether it should be given less weight than other national regulations. At the local level, Shanghai and Shenzhen each enacted their own separate guidelines for the establishment of stock companies (Wang, 2000, p. 218).

Pursuant to the reform known as the 1992 Opinion on Standards for Companies Limited by Shares as required by the Share Enterprise Trial Measures initiative, while a Chinese company is permitted to issue common or preferred shares that are comparable… [END OF PREVIEW]

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