Reduction Of Shareholding Control, Transaction Costs And Corporate Valu

Major shareholders,directors,supervisors and executives of listed companies are defined as insiders.Since they naturally have an edge of information advantage over outside investors,they can use their private information to trade in their companines’ shares and obtain excessive returns(i.e."insider trading").On the one hand,insider trading facilitates integration of specific information into the share price,enhancing market pricing efficiency.On the other hand,insider trading acts as an incentive for the management to put more effort into innovation activities.Therefore,most countries have legalised insider trading while also regulating it more strictly.However,how to maintain market fairness and improve the efficiency of market resource allocation has been a regulatory challenge faced by capital market regulators around the world.In order to regulate insider trading,especially shareholding reduction,and to maintain a fair and efficient capital market,Chinese government has taken a cautious and strict regulatory approach,since 2006 when the Company Law allowed insiders to transfer their shares in the secondary market.China has become the first country to implement mandatory pre-disclosure as an "ex ante" regulation.On May 26,2017,China Securities Regulatory Commission(hereafter,CSRC)released Announcement[2017] No.9,the revised Several Regulations on the Reduction of Shareholdings by Shareholders,Directors,Supervisors and Senior Executives of Listed Companies(hereinafter referred to as the “New Regulation”),which provides specific requirements on different transactions(M&A,private offering,introduction of strategic investors,etc.),different groups of people(large shareholders,specified shareholders and the management),and different periods of service and separation.On May 27,the Shanghai Stock Exchange and the Shenzhen Stock Exchange simultaneously issued the Detailed Implementing Rules of the Shenzhen Stock Exchange for Shareholding Reduction by Shareholders,Directors,Supervisors and Senior Executives of Listed Companies.In addition,compared with the old rules,the regulation scope of the new rules extends from a reduction of more than 5% in the number of major shareholders and the directors to a reduction in the number of shares held by specific shareholders,that is,shareholders holding pre-IPO shares of a company and holding non-public shares.The selling of the non-public sharesthrough collective bidding should not exceed 50% of the shares subscribed within one year after epiration of the selling-ban.For insiders,the search for counterparties has been made more costly by the addition of transferees to large deals,which not only face limits in collective bidding market,but also more tightly regulated by over-the-counter block trading market.External investors face higher holding costs and liquidity constraints due to restrictions on their future selling,especially for investors who subscribe to non-public offerings.What impact would such a setup have on insiders who already own shares and outside investors who are expected to own shares? What would be the impact on their trading behavior,operating and investment decisions? What would be the economic consequences of a change in decision making?This paper analyzes the explicit changes in trading behavior,implicit insider management decisions and external investment decisions.The main findings of this paper are as follows:(1)From the aspect of transactions:after the implementation of the reduction control,the discount rate of block trading increased significantly.At the same time,the lower the discount rate of block trading,the higher the level of quarterly positive earnings management the company disclosed before the release of the shares.The relationship is more significant when the financial reports releasing date is closer to the expriation date of the shares,when the sellers are main directors,and when the quality of internal controls is low.This indicates that the lockup period increases the liquidity constraints and liquidity risks of the transferee,and thus requires the transfers to compensate for the losses by offering a larger discount on the transaction.In order to mitigate the loss of the extended discount,the transfers and the transferees conspired by promising the transferee to reduce their shares at high price in bidding market through earnings management prior to the expriation date,in exchange for a smaller discount on the first time selling by insiders.The establishment of the lockup period increases the risk of a share price crash during the tradable period of the transferee’s shares,and the risk of a share price crash in that range is significantly positively correlated with the management of the Company’s quarterly accrued earnings prior to the lockup.Positive earnings management prior to the expriation date is significantly positively related to the accumulated abnormal return of the stock in the short window before and after the expriation date,indicating that the transferee conspired to achieve the desired effect by using surplus management to create momentum for the transferee to reduce its holdings after the release period.After the implementation of the reduction control,the level of quarterly earnings management before the release of the transferred shares is significantly higher than the level of earnings management in the same window before the reduction.This indicates that the control of divestment has strengthened the collusion motive of earnings management in exchange for lower trade discount,and provides a time window for earnings management.The increase in the discount rate caused by the lockdown triggered collusion between the big players,which reduced the quality of the company’s earnings and further increased the risk of a share price crash.(2)At the firm level,from the perspective of insiders: in the face of excessive transaction costs resulting from the regulation,some large shareholders who choose to reduce their holdings collude in trading to reduce transaction costs and reach deals to meet their cash flow needs.However,some insiders who have difficulty finding counterparties still have to hold shares for a long time,while others compensate for their financial needs and personal utility through corporate hollowing out,in the form of more capital consumption,more aggressive dividend policies,and more associated transactions.The hollowing out caused by divestment control is more serious in non-state-owned enterprises,mainly because the divestment control has more influence on non-state-owned enterprises and the control effect on state-owned enterprises is less.Corporate hollowing is more severe in companies that have not actually reduced their holdings,mainly because insiders who have not reduced their holdings have more incentive to make up for it in other ways,while insiders who have reduced their holdings have met their needs of cash flow,or have lost their insider status by reducing their holdings.Compared to the control group with a lower propensity for divestment,the experimental group with a higher propensity for divestment was more heavily regulated and hollowed out,and insiders were more self-interested in the short term,to the point of further reducing the firm’s investment in innovative research and development(patents),which led to poorer future performance and lower company value.(3)At the firm level,from the perspective of outside investors: the regulation means that once investors in business,future sharesselling is more difficult.The expected increased risk to investors and the increased cost of holding shares result in lower investment incentives or greater trade-in compensation for investors to invest,which in turn increases the cost of equity capital for enterprises and results in more targeted premium discounts.As the cost of equity capital and financing constraints increase,companies will change their financing methods and issue more convertible bonds.The main contributions of this paper are as follows: firstly,it enriches the research on large volume trading,extends the research on the characteristics of large volume trading price to the company level,finds the relationship between the discount price and the degree of earnings management and the risk of stock price collapse from the perspective of the insider’s divestment behavior,and verifies the possible trading collusion in block trading market.It not only provides a new perspective for investors to understand the impact of lock-up period on block trading,but also provides a reference for market regulators to improve the block trading system.Secondly,from the viewpoint of government control theory,the paper proves that the new regulation has some negative effects,including the collusion of trading caused by the lockdown period of large volume trading,and insiders choice of holding shares to avoid the transaction cost of reducing stock holding to meet their personal cash flow needs by encroaching on the company’s interests,and to compensate for the loss of profits,and to be more shortsighted in business decision,which leads to lower investment and output of research and development,ultimately,lower performance of the company.Third,enrich the research on insider trading and major shareholder tunnelling.We expand insider research from trading behavior to economic consequences at the corporate level,and expand the motivation of major shareholder tunnelling from internal corporate governance characteristics to more serious tunnelling behavior caused by external policy shocks.Fourthly,it supplements the research related to the cost of capital to verify the impact of shareholding reduction controls on financing costs from the perspective of investors’ investment incentives and risk expectations.The research results help to facilitate the regulators’ thinking on the cost of benefits arising from the protection of small and medium-sized investors and the protection of large shareholders.Fifthly,the research methodology is innovative.Previous studies on insider trading have been conducted using real transaction data,which in fact is difficult to fully capture the effect of the policy because insiders who are subject to strong controls may not engage in shareholding reduction transactions,so it is difficult to reach this part of the sample by only using real transaction data.Therefore,this paper uses the pre-policy trading data as the basis for predicting the future propensity to reduce holdings.Firms with a higher propensity to reduce holdings are more affected by the regulation and vice versa,and this is used to divide the treat groups and control groups for constructing a difference-in-difference analysis to assess the policy effect more effectively.