In the early 1980s, China began its reform program at a particular moment in context of a unique economic history and created its own distinctive approach to financial development and financial reform. As a communist nation, the political system cause china can not completely follow financial reform and development experience from capitalist society. Therefore, China had to combine its own political condition and common economic knowledge to set up a unique 'socialist-market economy' by reform agricultural sector, ownership of state-owned enterprises and the property rights. Western economist often describe this way as 'gradualism' and some literature argue that China's economy reform is not a planed reform, but just push it to a consistent way to satisfy the increasing demand of society and creating appropriate social climate for economic development.
In mid 1980s, the central and local financial department of the government began to decrease or stop giving large amount of financial budget to support the large SOEs, because the government started the fiscal decentralization reform and prepared for the future reforming of the ownership in large state-owned- enterprises (SOEs). Instead, the banking sector replace the government fiscal sector becoming the main source of providing long term Loans. However, till 1994, the percentage of non-performing loans (NPLs) reached 20% of total loans and during that period the banking sector required to improve the liability-asset management. What's more, the SOEs soon find out high transaction costs borrowing from bank causing them face debt-servicing problems. Especially during the financial crisis period, high inflation rate put a pressure on government to increase interest rate for stabilizing price level, but putting the SOEs in this situation will not be able to repay extremely high loan costs. On the other hand, by the early 1990s, the liabilities of SOEs have reached a very high percentage of their total asset, and they also faced severe working capital shortages. Largely of this situation was attributable to the lack of flexible fundraising channels.
To solve the predicament in both banking sector and SOEs, the Chinese authority finally determined to reform the ownership of state-owned-enterprises (SOEs) domestically. The aim is to improve performance of the low profitability, inefficient SOEs by transferred the ownership from state owned to public owned to stimulate the company's market competitiveness. In other words, the SOEs issues shares to public investors or other interested groups to realize propose of SOEs reform by decreasing the government inference and adding more source of financing for the company. Various owners provide more available suggestions for decision making, monitor corporate governance and advise the future development for the company. The communication between the shareholders and company director will satisfy both sides' prospects. The board will represent most shareholders' voice by voting to decide company major issues. In mid 1980s, the central government and province authorities sold some portion of ownership in SOEs to internal employees or public investors but still being the largest shareholders to help ensure stable operating and for certain social objectives (i.e keeping stable employment level). Employee shares are those offered to staff and management directors of listed companies to provide a benefit thanks to their contribution to the companies or an incentive to work harder rather than raise capital for firms. Moreover, some SOEs leave certain percentage of initial share issuing plan and internal employees can purchase those percentages on IPO price. After the initial holding period of six to 12 months, employees are able to sell their shares on stock exchanges.
To go through this problem, many enterprises start to look for new source of fund. At the same time, like other emerging economy, the GDP growth bring the increasing of income and improve of living standard, and individual investor began to seek ways to invest their saving on and not just put them in the bank. As the result, some informal IPOs have carried out by enterprise and they issued shares to internal employees and individual investors.
With respect to laws, regulations and supervisions, the government established the State Council Securities Commission (SCSC) and the China Securities Regulatory Commission (CSRC) in 1992 as primary regulators. The Company Law--containing provisions on issuance, transacting, and listing of public securities--was introduced in 1994. The SCSC and the CSRC were then merged in April 1998 to form one ministry rank unit directly under the State Council as part of the government's plan for improving regulatory effectiveness. In August 1998, furthermore, the Shanghai and Shenzhen stock exchanges were placed under the supervision of the CSRC. In November 1998, the authority to supervise local securities regulatory departments was transferred from the People's Bank of China to the CSRC. In 1999, the Securities Law became active, aiming to prohibit insider trading, standardize the issuing and trading of securities, improve disclosure, and protect investors.
Section 2: The Chinese stock market structure and recent development
In January 1985, Shanghai Yanzhong Industrial becomes the first corporation making vexchange (SHSE) was set up in December 1990 and several months later, the second market-Shenzhen stock exchange (SZSE) was approval to trade in April 1991. At present, shanghai and Shenzhen stock exchange are two authorized market in china mainland and in Hong Kong there is another market Hang Seng index.
Shanghai Securities Exchange (SHSE)
The Shanghai Securities Exchange was found on 26 November 1990, and open its first trading day on 19 december1990. As a non-profit membership organization, it trades A-shares, B-shares, investment fund shares, and treasury bonds listed on the market. According to the security trading rule, only those securities intuitions that also member of the exchange and registered traders represent those securities intuitions can enter the trading floor. Also, unless getting special permission from exchange, off-floor trading is prohibited and the member of exchange is also prohibited to be the member of another exchange. The shanghai stock exchange operate in an auction environment without a specialist or market maker system and also adapt the computer automatic matching system.
-The open auction outcry system
The trader in exchange cries out the price and volume the customer's order on trading floor. The trader may not change the price customer required unless another trader cries out a lower price than the customer' order. Once the offering price has been matched, a trading report with the execution price will be transmitted and then demonstrate on the computer trading system.
-The computer automatic matching system
The computerized system is based on the principle of priority and time priority. The system automatically matches the closest offer and bid which has a capacity on 5000 deals per second. With the help of the satellite-based telecommunications network, the trading information on both auction and computer system is able to instantly deliver to all parties across the country.
Shenzhen Securities exchange
The Shenzhen Stock exchange was found on 1 December 1990 as a non-profit membership organization. As with the shanghai securities exchange, it trades A shares, B shares, investment fund shares, and the treasury bonds listed on the Shenzhen securities exchange. Also, as in the case of the shanghai securities exchange, only members of the exchange and those traders of members who are registered with the exchange can access and trade on the exchange floor, and off-board trading by members is prohibited. SZSE has adopted a market trading system based on modern computerized and telecommunications technology, fully practiced electronically automated trading. Based on the principle of price priority and time priority, the system offers concentrated bidding and matches offer and bid deal by deal, with a daily capacity of ten million commissions. Currently, the A-shares market adopts T+1 settlements and the B-share market uses T+3 settlements.
Both Shenzhen Stock Exchange and Shanghai Stock Exchange have a daily price movement limit system. Although the comprehensive influence that such a system has on the stock market is still a controversial subject in academic literature, Lee and Chung (1996) did find that the price limits have the potential of biasing the stock market efficiency hypothesis. Using the data from Korean Stock Exchange, their study concluded that by setting price limit a lower volatility is attained at the cost of reducing the stock market efficiency.
There are in total five types of shares issued by the companies in China. They are namely A-shares, B-shares, C-shares, H-shares and N-shares.
A-Shares are the shares that are available to domestic investors, and they are denominated in the Chinese currency, Renminbi(RMB), subscribed for and trade in RMB by domestic investors. A-shares can be further classified into four categories according to the ownership: State holding (held by the government or its agencies), legal-person holding (held by employees), and individual holdings (held by the public). Currently, shares held by the general public are the only shares that can be traded on the exchange, although some selective trading of the internal and legal-person shares is very active in an over- the-counter market.
B-Shares. The second class of shares is the B-shares denominated in RMB, but subscribed for and traded in either the US dollar or the Hong Kong dollar by foreign investors. The US dollar B-shares are traded on the SSE and the HK dollar B-shares are traded on the Shenzhen Stock Exchange.
C-Shares. C-shares can only be traded among Chinese state institions, enterprises and departments with a legal person status. C-shares are traded over-the-counter and individuals are not allowed to hold C-shares.
H-Shares and N-Shares. In July 1993, Chinese companies were permitted to list on the Hong Kong Stock exchange and the shares they issued in Hong Kong were named H-shares. N-shares represent the shares listed on the New York Stock Echange in the form of American Depository Rceipts (ADRs).
The government has not allowed overseas registered firms to list on the domestic equity market. Almost all issuers of domestic and overseas shares remain state owned enterprises. Domestic private firms have, however, increasingly listed on Hong Kong's main board and grown enterprise market in recent years, given that they have to wait in along queue to be approved for listing on the A-share market while the B-share market is currently shut to new offerings. An increase in domestic private issuers abroad is governance and performance but also that of other domestic firms by intensifying competitive pressures in both the domestic and oversea product markets.
In December 2002, the Qualified Foreign Institutional Investors (QFII) system was set to permit large foreign institutional investors to invest in local-currency denominated securities (including A-shares) with the ceiling of 10% of shares in a listed firm per each QFII and 20% of total shares for all QFII. 2 While this system excludes small foreign investors, it is the first step in the long-awaited process of opening China's capital account to portfolio inflows.
Section 3: The bubbles in Chinese stock market
After 7 years of bearish performance, the bullish market finally emerged in 2006. With 18 months, the Shanghai Stock exchange index had risen more than three times, and reached 6124 on 16 October 2007. Immersed in happiness of making profit, few market players worried about the burst of share price and someone even said there are no bubbles existing at all. When bubble is big enough, it certainly will break and the market downturn showed off. Since October 2008, the Chinese stock market had suffered an almost 71% loss from its peak in October 2007.
Section 4: The IPOs regulation and aftermarket performance1000
Section 5: Efficiency of the stock market
As one of the key theories of analyzing the stock market efficiency, the stock market efficiency interpret that the stock market is in efficiency when the fluctuation share price is fully reflecting the change of available information, which says that people cannot achieve return in excess of average market return on a risk-adjust basis, given the information publicly available at the investment is made. (Fama, 1970 No.1) there are three types of efficient markets: First one, the weak efficiency market which asserts the current prices fully reflect the information implied by the historical sequence of prices. In other words, an investor cannot enhance his ability to select stocks by knowing the history of successive prices and the results of analyzing them in all possible ways. Second one, the semi-strong form states that current prices fully reflect the public knowledge about the underlying companies, and that efforts to acquire and analyze this knowledge cannot be expected to produce superior investment results. Third one, the strong form efficient market is which price reflects all information and even the privileged information can not secure superior investment results.
Over the past decade, there have been numerous empirical duties on the efficiency of China stock market. However, after studying these literatures, it seems that Chinese scholars still cannot draw a qualitative conclusion about whether the Chinese stock market is efficient or not. Song and Jin (1995) found evidence supporting that the stock market is already in weak-form efficient. However, the studies form Zhang and Zhou (2001) points out that even though sometimes it looks like the index follows a random walk, it is still too early to state the stock market has already been weak-form efficiency.
Despite that an increasing number of studies in early 2000s found evidences which shows the Chinese stock market has already been weak-from efficient, it's still hardly to believe the emerging Chinese stock market is able to become boom and efficiency just in a decade time, without problems like government still inference the market and setting the restrictions on stock trading, lack of market regulation, and investors' speculation psychology,. On the other hand, by using relative valuation methods testing the share price be underpricing or overpricing, Guoping Li (2008) found evidences state that the stock market is still inefficient. In Li's studies, there are mainly three methods being used in testing efficiency of China's stock market: (1) the ratio of share price to the value of discounted dividend; (2) Tobin's Q; (3) the ratio of market capitalization growth to nominal GPD growth.
The ratio of share price to the present value of dividend (using the discount rate)
This theory states that the share price is the present value of all future dividends of that share, therefore, the ratio of share price to the present value of dividends (using the discount rate) should be equal to 1 if the stock market is efficient. (Gordon, 1962) Namely, if the ratio is more than 1 which represents the share price is overpricing and less than 1 represents the share price is underpricing. In Figure 1, it presents the ratio of share price to the value of discounted dividend of Chinese stock market.
Figure 1, the ratio calculated from the present value of dividends
Source: China Securities Regulatory Commission, 2008 China Securities and Futures Statistical Yearbook 2007, Beijing: Xuelin Press
From figure 1, during year 1993, 1996-1997, 1999-2000 and 2007, China's share price is more than twice the present value of the dividends, which means the share price is overpricing. However, in 1994-1995 and 2005, the stock market shows underpring condition. According to the Gordon theory, if the stock market is in efficient, changes in share price should be positive correlated to the changes in dividend paid to investors. Moreover, the volatility of dividends should be equal or more than the volatility of share prices.
The figure 2 demonstrates the trend of the Shanghai Composite index and the trend of yearly dividends paid by listed company on Shanghai Stock index from 1993 to 2007.
Figure 2, Shanghai Composite Index versus Dividends, 1993-2007
Source: Data on Shanghai Composite Index from the National Bureau of Statistics of China website (2007): http://www.stats.gov.cn. Yearly dividends are calculated using data from CSRC (2008).
With a negative correlation coefficient, the trend of stock index was significantly negatively correlated to the trend of dividends paid from 1993 to mid of 1995. What's more, from the 2005-2007, the boom of market push the stock index extended nearly 4 times, but the amount of the annual dividends just stay at a stable rate. By using the data from National bureau of statistics of China from 1993 to 2007, Shujie Yao (2009) found that the variance of changes in share price is 0.24, however, the change in dividends is only 0.037.
(2) Tobin's Q
Tobin's Q is created by James Tobin in 1969, which is the ratio between company's market value and replacement value of the same physical assets. The Tobin's Q is regularly used to judge the misevaluation of a company as well as the company's management performance. (Tobin, 1969)
The calculation formula is:
If the market value truly reflects the recorded value of company's physical assets, the Tobin's q should equal to 1. If the ratio is more than 1 or less than 1, it interprets the market value is underestimated or overestimated. Furthermore, using the Tobin's Q, it also can measure the general level of misevaluation of whole China Stock market, and then the ratio can help to analysis the efficiency of the stock market.
The alternative formula should be used:
Where Qt is Tobin Q at time t and QT is the moving average value of Tobin's Q up to time t. Therefore, if the whole market is in efficient, the index should be equal to 0. The result is demonstrated in figure 3.
Figure 3, the index calculated from Tobin's Q
Source: data including market capitalization and net assets are taken from CSRC (2008).
In figure 3, with index equal to 0 as the standard, the years of 1996-1997, 1999-2000 and 2007, the total value of China's stock market was overestimated and 2002-2006, the value was underestimated. The year 2001 and mid 2006, the index nearly reached to 0, but means the stock market was in efficient in very short time.
(3) The Ratio of Market Capitalization Growth to Nominal GDP Growth
By using the ratio of Market Capitalization Growth to Nominal GDP Growth as a measurement to test the efficient of the stock market, Zhang and Bao (1999) found that the existing of misevaluation of the Chinese stock market and there is positive correlation between GDP growth and stock market development. From their study, if using the mature and efficient markets like USA as a standard, the ratio below or over 4 indicates the stock market is underpricing or overpricing. Their Testing result is shown in figure 4
Conclusion (500)
