Chinese Commercial Banks Equity Financing Pricing Study

The valuation of commercial banks is one of the most challenging issues in the discipline of modern corporate valuations, and getting a correct price for equity financing of mainland commercial banks is even more challenging. Commercial banks have unique capital structure and operation characteristics, and are subject to stringent regulations on capital adequacy and exposure guidance. All these factors make it difficult for outsiders to know the asset quality, the credibility and accuracy of a bank correctly, to estimate the impact of interest rate and duration mismatches.The banking industry is the core element of China's financial system.80% of total capital financing in China is provided by commercial banks through loans and other financing instruments. With the gradual implementation of the top-down banking industry reform, mainland banks are involveing in a serices of reforms including the separation of government and banks, joint stock reforms, the introduction of strategic investors, initial public offerings, and refinancing at appropriate times. Among these steps, the introduction of strategic investors, the initial public offering and the refinancing are inevitab related to pricing for the equity of banks. The determination of the appropriate pricing for equity financing has become one of the hot topics for both scholars and practitioners in the financial sector.Based on the background, this study focuses on three questions:(1) Why is the valuation of banks differs from those of other enterprises? Among the several bank valuation methods, which one is the most appropriate for commercial banks in China? (2) Given that the intrinsic value of a bank almost the same, why do the prices for the introduction of strategic shareholders, the initial public offering and the refinancing differ so substantially? What are the factors that affect the pricings during these periods? (3) Is it possible to design a system and mechanism that could enable a correct pricing for bank stocks during different periods to balance the interests of different stakeholders?This study is based on the theoretical analysis, complimented by a questionnaire survey and case studies. It involves both quantitative and qualitative analyses. Basing on the operation and regulatory characteristics of commercial banks, this study analyses different valuation method and finds the most appropriate one for valuating the intrinsic value of commercial banks. Latest data and cases in the capital market and financial sector are used to find the factors affecting the pricing for equity financing of Chinese commercial banks. The key content and conclusions of the study are as follows:(1) Review of valuation theories for ordinary enterprises, including the assumptions, models, strengths and weaknesses of these theories, analyze the characteristics of commercial banks. We prove that the dividend discount model is the most appropriate method in determining the intrinsic value of commercial banks, and explain the calculations of parameters in this method. Our theoretical and logical inferences are further verified through aquestionnaire survey for staff in key international and domestic investment banks.(2) We analyzs cases of previous introduction of strategic investors in the Chinese banking industry, and performe a theoretical analysis on the pricing of the shares transferred. We analyze the factors that affected the pricing of shares for the major commercial banks to reach the share transfer agreements. We find that the main factors affecting pricing included information asymmetry faced by foreign capital, share transfer ratio and control premium. Private placement, the holding lock, institutional factors related to negotiations and share price also influence the pricing of shares. Besides, the contrast of the bargaining power between Chinese and foreign parties in the negotiation stage, the motivation and input of foreign capital, the package deal of share transfer and the macroeconomic environment are factors that related to the pricing.(3) We performe a theoretical analysis of IPO pricing and conduct a questionnaire survey on the choice of valuation methods for equity pricing. In addition, we use ICBC as a case to study the valuation methods used by multi-investment banks during commercial banks'IPO stage. In regarding to factors affecting the pricing of IPO, the time window, listing place, issue size, subscription ratio and underwriters of IPO are five important aspects that need to consider.(4) We analyzed the different effects of three ways to refinance, including allotment of shares, additional share and convertible bonds. Then combining the characteristics of three forms of re-financing, we analyzed the methods of bank refinancing and pricing related factors with the latest case and data. Refinancing stage, the banks need to consider the economic situation at that time, market expectations, its own operation characteristics, capital structure and even the development strategies to choose the proper way of re-financing. The current trading price of the stock, stock issue size and volatility of stock prize have important effects on the price of refinancing.Based on the operation and regulatory characteristics of commercial banks, we studied the valuation methods for the intrinsic values of banks. Through questionnaire surveys with key institutions and analysis of the latest data and cases in the capital market, we attempted to analyze the factors that affect pricing in the introduction of strategic investors, IPO and refinancing. Compared to previous studies, we accomplished innovations in terms of theory, perspective.Theory innovation:There is few existing literature that either systematically study the equity pricing of commercial banks or explain how Chinese commercial banks valuate and price equity during the stages of introduction foreign investment, initial public offer and re-financing. This article does not talk about the difference in valuation features between commercial banks and other businesses generally. Instead, we perform in-depth analysis on the operating and institutional feathers of commercial banks and thus logically derived dividend discount model (DDM) is the most suitable model for the valuation of commercial banks. In the DDM model, the fundamental analysis of commercial banks, CAMELOT, is the best way to determine the Beta parameters. The equity price of commercial banks during the foreign capital introduction stage, public list stage and refinancing stage are quite different, that could be explained by the main factors affecting pricing.Perspective Innovation:Theory comes from practice and practice is the sole criterion of truth. To understand how the capital market determines the intrinsic value of Chinese commercial banks, we issued questionnaires to 64 renowned domestic and international institutions, and received 58 valid replies, including replies from 15 renowned international and domestic investment banks, and 15 key international and domestic institutional investors. The survey provides an effective verification on which valuation method is the most appropriate for Chinese commercial banks. In the study, we performe both in-depth analyses of individual cases and multi-cases analysis, and have taken into account both the practical background and the actual implementations of the valuation methods.Due to the uniqueness of the banking industry, there are not many ready-made theory and literatures for reference. Some of the views elaborated in this article are exploratory and still need further study. This article discusses the influencing factors of pricing by theory, case study and statistical analysis. To what degree would these factors influence pricing are not analyzed by strict empirical research. We intend to focus on the question in the follow-up studies.