The impact of the full circulation reform on Chinese security prices and valuation

Abstract

Since the establishment of China stock markets in early 1990s, two thirds of China domestic shares were held by the central government or their representatives and only about one third were issued to the public investors. Government shares were not allowed to be traded publicly while the otherwise identical shares were freely-traded. This unique split share structure can lead to conflicts of interest between tradable and non-tradable shareholders and has been recognized as the source of many corporate governance problems in China. In early 2001, the Government unsuccessfully decided to sell its ownership of the listed enterprises as the market collapsed under severe price pressure. In 2005, China Government launched Full-Circulation Reform to convert the non-tradable government shares into traded shares. The event consisted of a series of sub-events, including announcement of macro policies and subsequent firm-specific decisions. China Full-Circulation Reform was set to protect the interests of minority shareholders by (1) allowing companies to devise their own proposals which took in opinions from both the holders of non-tradable and tradable domestic shares; (2) requiring the owners of non-tradable government shares paying Consideration to the owners of tradable domestic shares to compensate them for any anticipated loss; and (3) imposing some restrictions on the sale of government shares. In this thesis the event-study method is employed to investigate the effect of China Full-Circulation Reform on China stock markets. In particular, whether the scheme was fair to both tradable and non-tradable shareholders and what factors were important in the outcome. The results suggest that the procedure taken by the Government to protect the minority interests in the reform was successful with the tradable shareholders not losing in the reform. And the main objective of maintaining the market stability while floating the non-tradable government shares had been successfully achieved.