China's Listed Companies Tradable Share Reform

On 29 April 2005, the China Securities Regulatory Commission (CSRC) promulgated the Notice on the Trial Implementation of Measures to Tackle Segregation of Share Capital in Listed Companies and Related Questions, starting the pilot program to restructure share capital of listed companies by converting the non-tradable shares (NTS) into tradable shares. It is expected that the share capital segregation reform of listed companies will have basically completed by the end of 2006. This dissertation is about the research focusing on the reform.In this dissertation, the cause and consequence of share capital segregation as well as the necessity of its reform are discussed. The development of the reform is reviewed and its prospects predicted. Besides, major issues and difficulties concerning the reform, such as the reform patterns and commitments are analyzed with a view to pushing forward the reform in an effective way.One of the fundamental issues of the reform is the level of compensation the holders of NTS should give to the holders of tradable shares. In this dissertation, the game between the NTS holders and tradable holders with regard to the compensation, the methods of compensation and the factors that influence the compensation schemes are examined respectively. In particular, an empirical research included in the dissertation reveals that among all the factors influencing the compensation arrangements, the asset size of the listed company and the percentage shareholding held by the holders of A shares in the total share capital have crucial impact on the level of compensation. In addition, several tough issues involved in the reform including the reform pattern, the undertakings by NTS holders are also discussed.The impacts of the reform on the share price are explored by three pieces of empirical research intended to answer the following questions: will the reform increase the value of the listed company? To what extent does the inside information of the reform affect the share price? Has China's capital market become semi-efficient market? The conclusion is that the reform did improve the value of companies though the share prices have been affected to a great extent by inside information, and that China's capital market has not become semi-efficient market yet.As for the issue of large share holders' manipulation of profits, our research concludes that (i) no matter whether the share price reaches the agreed transferring price or not, large share holders always have incentives to manipulate the profits of the listed company and the extent of manipulation depends on factors including the larger shareholder's shareholding percentage, P/E ratio and the real profits of the company; (ii) no matter whether the real profit of company meets the condition for financing, large shareholders always have incentives to manipulate profits of the listed company and the extent of manipulation is related to the financing amount in a complex way. The correlation between the two is influenced by factors including theproportion of company fund used by larger shareholders, the shareholding percentage of large shareholders, P/E ratio, the real profit of the company and the regulatory cost.This dissertation also explores the pricing of the converted shares subject to restricting conditions ("restricted tradable shares") by focusing on pricing of two types of restricted tradable shares, i.e., the converted shares with "lock-up" period and the converted shares whose selling prices subject to certain restriction. As for the former, three models are proposed for their valuation, i.e. two-phase adjusted required rate of return model, Longstaff model and option model. With regard to the latter, two scenarios are differentiated in the analysis taking into account the "lock-up" period. Furthermore, in our analysis, the value of the converted shares without "lock-up" period is unbundled into the value of non-tradable shares and the price of warrants while the pricing of the converted shares with 'lock-up" period is approached with two methods, the method used for pricing American call options and the method of modified binominal tree model. In order to explore the micro-foundation of the pricing of the restricted converted shares, a simplified model is constructed to discuss the pricing of converted shares with "lock-up" period.In the post-reform period, the capital market will be stable only if the expectation of both shares supply and funds supply are stabilized. To this end, on the one hand, it is necessary for the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) to stipulate the minimum requirement for the state shareholding in each trade; on the other hand, ETF funds resembling the Tracker Fund of Hong Kong should be introduced for the purpose of stabilizing the share price in the market while lessening state-owned shares.