Study On The Market Reaction Around Delisting And Factors Affecting Involuntary Delisting In China

Delisting refers to the exclusion of a stock from the list of stocks that are traded on a certain stock exchange. Delisting may be voluntary or involuntary. Voluntary delisting may result after a merger, acquisition or going private transaction. Involuntary stock delisting is almost always initiated by the stock exchange management following failure of the firm to comply with certain continuing listing requirements. Prior literature has established that there are significant economic costs associated with delisting events in terms of reduced stock prices, eroded liquidity and amplified volatility, In China, the China Securities Regulatory Commission is charged with the responsibility of formulating regulations for initial listing and delisting criteria for the stocks. If the firm violates a minor regulation the stock is issued special treatment, if the firm violates a major regulation the stock is issued delisting risk warning and in extreme cases the stock is delisted from the exchange. The delisting regulations of China are unique in terms of the delisting procedure adopted by the China Securities Regulatory Commission. To the best of my knowledge, there is no study available on the economic impact of involuntary delisting in China, hence a motivation for the current research.Furthermore, prior literature has investigated the association of financial variables with adverse organizational outcomes, e.g., bankruptcy and acquisition, and corporate governance variables with firm performance. There are few researches that investigate the association of corporate governance variables with involuntary stock delisting but, to the best of my knowledge, none of these studies are carried out in Chinese context. The corporate governance practices in China are quite different from American or German/Japan model establishing the need to examine possible effects of governance practices on the probability of delisting in China. The two main purpose of this research thesis are to assess the market reaction around events related to delisting regulations in China and to assess the impact of corporate governance structure on the probability of involuntary delisting in China. The events associated with delisting regulations in China include change of listing status:from normal to special treatment, normal to delisting risk warning, delisting risk warning to special treatment, delisting risk warning to normal, special treatment to normal, special treatment to delisting risk warning, and involuntary delisting. To assess the market reaction around these events I used a sample of1281events for’A shares’ listed on Shanghai and Shenzhen stock exchange of China between the period1990-2012. I used standard event study methodology to measure the average abnormal returns around these events. I used market model to estimate abnormal returns and employed mean adjusted returns model to check robustness of the results. I show that the market is more sensitive to negative event announcements compared to positive event announcements. Similarly, the market is more sensitive to a direct change in status between normal and delisting risk warning compared to normal and special treatment and/or special treatment and delisting risk warning. The average decline in stock prices upon delisting is85percent which represents a highly significant cost to the stockholders. These findings are new and provide insight to investors and regulators regarding economic costs of different type of events associated with delisting regulations in China.To assess the impact of corporate governance on the probability of involuntary delisting in China I used an exhaustive list of involuntary delisted’A shares’from Shanghai and Shenzhen stock exchange from the period1990to2012. I used match pair sampling technique to form an industry and size controlled sample of delisting and surviving firms. I used discriminant analysis and logistic regression to analyze the impact of corporate governance characteristics on involuntary delisting at three different periods in time prior to delisting:three years prior to delisting, two years prior to delisting and one year prior to delisting. Initially, I used all the corporate governance variables for which data is available for the Chinese firms and reduced the number of variables through trial and error procedure. I used following board and ownership characteristics to proxy for corporate governance structure:board size, board activity, board independence, presence of audit committee, shareholder activism, inside ownership and ownership concentration. I find that shareholder activism and board independence significantly affects probability of delisting at one year prior to delisting. Board activity significantly affects probability of delisting in the consecutive two years prior to delisting. Ownership concentration significantly affects probability of delisting at three and two years prior to delisting. Insider ownership is significant in all three years prior to delisting while presence of audit committee and board size has no impact on probability of delisting in China. I broadly conclude that in case of China, ownership characteristics are more significant in distinguishing delisting firms from surviving firms compare to board characteristics.