Topics in Chinese Economic Issues

- Chinese Stock Market

Yanchu Wang
Shanghai University of Finance and Economics
Fall 2024

Fall 2024 YW(SHUFE) Chinese Stock Market 1

Introduction

◼ Chinese stock market is very different from most of the stock markets in
the world
❑ Set up and development

❑ Companies listed

❑ Rapid growth

◼ Explore the unique features of Chinese stock market

◼ Discuss and share your unique thoughts
◼ How we can use Chinese stock market
❑ To finance

❑ To invest

Fall 2024 YW(SHUFE) Chinese Stock Market 2

Outline

◼ History and development of Chinese stock market

❑ National capital market took shape (1992 - 1998)

❑ Initial development stage (1999 - 2004)

❑ Rapid development stage (2005 - Now)

◼ Understanding the current Chinese stock market

❑ Facts: numbers, ratios, etc.

❑ Puzzles and potential problems: A-B share price discount, etc.

◼ Chinese financial derivatives market

Fall 2024 YW(SHUFE) Chinese Stock Market 3

Other Information

◼ Email: [Link]@[Link]
❑ Feel free to email me if there is any question

❑ Schedule an appointment with me

◼ Office: Tongde 319

Fall 2024 YW(SHUFE) Chinese Stock Market 4

Outline

◼ History and development of Chinese stock market

❑ National capital market took shape (1992 - 1998)

❑ Initial development stage (1999 - 2004)

❑ Rapid development stage (2005 - Now)

◼ Understanding the current Chinese stock market

❑ Facts: numbers, ratios, etc.

❑ Puzzles and potential problems: A-B share price discount, etc.

◼ Chinese financial derivatives market

Fall 2024 YW(SHUFE) Chinese Stock Market 5

History and development – Prior Stage

◼ Before 1992
❑ 1979 – China open up

❑ Middle of 1980s – Establishment of publicly traded limited corporations

◼ November 1984 – Shanghai Feiyue (first publicly traded company)

◼ May 1987 – Shenzhen Development Bank issue the first Shenzhen

stock publicly
◼ 1988 – Shenyang Jinben issued shares publicly

◼ 1988 to 1989 – Beida and Dalian Longquan issued shares publicly

Fall 2024 YW(SHUFE) Chinese Stock Market 6

History and development – First Stage

◼ Before National capital market took shape (1992 - 1998)

❑ December 1990 – SSE (Shanghai Stock Exchange) and SZSE (Shen

Zhen Stock Exchange) started operation.

❑ October 1992 – CSRC (China Securities Regulatory Commission) was

established to exercise centralized regulation over China capital

markets.
❑ November 1997 – Chinese government set out the principles of separate

operation of banking, securities and insurance players in China financial

sector.

Fall 2024 YW(SHUFE) Chinese Stock Market 7

History and development – Second
Stage
◼ Initial development stage (1999 - 2004)
❑ 1999 – Securities Law was promulgated, providing the legal framework

governing China capital markets.

❑ 2000 – CSRC decided to “encourage the development of institutional

investors”, largely improving the investor base in China capital markets.

❑ The approval mechanism was in place instead of quota mechanism for

share offerings

Fall 2024 YW(SHUFE) Chinese Stock Market 8

History and development – Third Stage

◼ Rapid development stage (2005 - Now)

❑ April 2005 – CSRC launched the non-tradable share reform, which was

basically completed by end of 2007

❑ Between 2004 and 2009 – CSRC set forth the sponsorship mechanism

and offering mechanism reform to further liberalize company offering

practices
❑ 2010 – Stock index futures and stock borrowing and margin trading

were launched to deepen China capital markets reform.

❑ Since 2016, a number of larges SOEs, including the “Four Big” SOE
banks, Petro China and China Shenhua listed on the A-share market.

Fall 2024 YW(SHUFE) Chinese Stock Market 9

Number of Listed Companies for China

Fall 2024 YW(SHUFE) Chinese Stock Market 10

Chinese Stock Market - Overview

◼ Exchanges
❑ Shanghai

❑ Shenzhen

◼ Products
❑ A shares (RMB)

❑ B shares (Foreign currency)

❑ Government Bonds

❑ Corporate Bonds

❑ Convertibles

❑ Investment Funds etc.

Fall 2024 YW(SHUFE) Chinese Stock Market 11

Chinese Stock Market - Overview

◼ The development of Chinese stock market must be understood in the

context of the “partial privatization: process of SOEs in the 1990s
◼ Unlike in most other countries where privatizations are through secondary
offerings, the Chinese privatizations were primary offerings that did not
involve subsequent secondary offerings, (Fan, Wang, and Zhang 2007 JFE)
◼ This creates differences and conflict of interests between non-tradable
(state and legal person) shares (NTS) and tradable (private investor) shares
(TS). (Huang, Shen and Sun 2011 JCF)
◼ As of February 2005 (immediately before the NTS reform), non-tradable
shares accounted for 63.51% of all outstanding stock. (Jiang, Lee and Yue
2010 JFE)
◼ The 2005 NTS reform involves the non-tradable shareholders proposing a
compensation package to the tradable shareholders in exchange for the
listing rights of their shares.

Fall 2024 YW(SHUFE) Chinese Stock Market 12

Outline

◼ History and development of Chinese stock market

❑ National capital market took shape (1992 - 1998)

❑ Initial development stage (1999 - 2004)

❑ Rapid development stage (2005 - Now)

◼ Understanding the current Chinese stock market

❑ Facts: numbers, ratios, etc.

❑ Puzzles and potential problems: A-B share price discount, etc.

◼ Chinese financial derivatives market

Fall 2024 YW(SHUFE) Chinese Stock Market 13

Understanding Chinese Stock Market

◼ Number of Listed Companies for China

◼ Total Share Prices for All Shares for China
◼ Stock Market Capitalization to GDP for China
◼ Market Capitalization Outside of Top 10 Largest Companies to Total
Market Capitalization for China
◼ Stock Market Total Value Traded to GDP for China
◼ Value Traded of Top 10 Traded Companies to Total Value Traded for
China
◼ Stock Market Turnover Ratio (Value Traded/Capitalization) for China
◼ CBOE China ETF Volatility Index

Fall 2024 YW(SHUFE) Chinese Stock Market 14

Number of Listed Companies for China

◼ Number of domestically incorporated companies listed on the country's

stock exchanges at the end of the year (does not include investment
companies, mutual funds, or other collective investment vehicles).

◼ Units: Number of Listed Companies per Million People, Not Seasonally

Adjusted

◼ Frequency: Annual

◼ Source: World Bank

Fall 2024 YW(SHUFE) Chinese Stock Market 15

Number of Listed Companies for China

Fall 2024 YW(SHUFE) Chinese Stock Market 16

Total Share Prices for All Shares for China

◼ Total Share Prices for All Shares for China based on the 2015 level

◼ Units: Index 2015=100, Not Seasonally Adjusted

◼ Frequency: Monthly

◼ Source: Organization for Economic Co-operation and Development

Fall 2024 YW(SHUFE) Chinese Stock Market 17

Total Share Prices for All Shares for China

Fall 2024 YW(SHUFE) Chinese Stock Market 18

Stock Market Capitalization to GDP for China

Fall 2024 YW(SHUFE) Chinese Stock Market 19

Stock Market Capitalization to GDP for China

Fall 2024 YW(SHUFE) Chinese Stock Market 20

Market Capitalization Outside of Top 10 Largest
Companies to Total Market Capitalization for China
◼ Value of listed shares outside of the top ten largest companies to total value
of all listed shares.

◼ Units: Percent, Not Seasonally Adjusted

◼ Frequency: Annual

◼ Source: World Bank

Fall 2024 YW(SHUFE) Chinese Stock Market 21

Market Capitalization Outside of Top 10 Largest
Companies to Total Market Capitalization for China

Fall 2024 YW(SHUFE) Chinese Stock Market 22

Stock Market Total Value Traded to GDP for China

◼ Total value of all traded shares in a stock market exchange as a percentage

of GDP.

◼ Units: Percent, Not Seasonally Adjusted

◼ Frequency: Annual

◼ Source: World Bank

Fall 2024 YW(SHUFE) Chinese Stock Market 23

Stock Market Total Value Traded to GDP for China

Fall 2024 YW(SHUFE) Chinese Stock Market 24

Value Traded of Top 10 Traded Companies to Total
Value Traded for China
◼ Value of all traded shares of the top ten traded companies as a share of total
value of all traded shares in a stock market exchange.

◼ Units: Percent, Not Seasonally Adjusted

◼ Frequency: Annual

◼ Source: World Bank

Fall 2024 YW(SHUFE) Chinese Stock Market 25

Value Traded of Top 10 Traded Companies to Total
Value Traded for China

Fall 2024 YW(SHUFE) Chinese Stock Market 26

Stock Market Turnover Ratio (Value
Traded/Capitalization) for China
◼

Fall 2024 YW(SHUFE) Chinese Stock Market 27

Stock Market Turnover Ratio (Value
Traded/Capitalization) for China

Fall 2024 YW(SHUFE) Chinese Stock Market 28

CBOE China ETF Volatility Index

◼ Chicago Board Options Exchange, China ETF volatility index

◼ Units: Index, Not Seasonally Adjusted

◼ Frequency: Daily, Close

◼ Source: Chicago Board Options Exchange

◼ Exchange Traded Funds (ETFs) are shares of trusts that hold portfolios of
stocks designed to closely track the price performance and yield of specific
indices.

Fall 2024 YW(SHUFE) Chinese Stock Market 29

CBOE China ETF Volatility Index

Fall 2024 YW(SHUFE) Chinese Stock Market 30

Understanding Chinese Stock Market – Overview

◼ China capital markets now stepped onto a new stage since 2006, driven by
successive IPOs of large SOEs

◼ Number of listed companies grows a lot – especially A shares.

❑ Growth of B shares is not very high, why?

◼ Market becomes more developed nowadays

◼ Big companies still dominate the market

Fall 2024 YW(SHUFE) Chinese Stock Market 31

Chinese Stock Market Characters

◼ China has become one of the most important capital markets globally
❑ One of three largest stock markets in the world (US & Japan)

◼ Retail investors still account for a large portion (40%), while institutional
investors play an increasingly important role (25%).
❑ Institutional investors’ contribution in turnover also increases (20%), but still
small compare to other stock markets (more than 50%)
❑ Rapid growth of China’s fund management companies (55 in 2000, 1000 in
2015)
❑ Overseas funding enters into A-share market via QFII (not only quota
increases, but also number increases)

Fall 2024 YW(SHUFE) Chinese Stock Market 32

Chinese Stock Market Characters

◼ Market wide multi-layered high PE ratio

❑ A large premium in IPO PE ratio
❑ Good post-IPO performance
❑ Create a funding platform for new industries
❑ Provide higher profitability growth

◼ Large information asymmetry, high IPO under-pricing level (Chan, Wang

and Wei, 2004 JCF)
◼ Synchronous stock price movements
❑ Suggest low stock price informativeness on firm level information (Morck,
Yeung and Yu, 2000 JFE)
◼ Firm investment does not significantly respond to the stock market
valuation (Wang, Wu and Yang 2009 JBF)

Fall 2023 YW(SHUFE) Chinese Stock Market 33

Puzzles and Potential Problems

◼ Puzzle of A-B share price discount

❑ A shares – RMB traded by domestic investors

❑ B shares – Foreign currency traded by foreign investors

Fall 2023 YW(SHUFE) Chinese Stock Market 34

A-B share price discount

◼ Information Explanation: foreign investors, who trade B-shares, have an

informational disadvantage relative to domestic investors, who trade A-
shares (Chan, Menkveld and Yang 2008 JF)

◼ Governance Explanation: foreign investors care more about a firm’s

governance quality than domestic investors. It is found B-share price
discount is higher for firms that have weaker governance. (Tong and Yu
2012 JIMF)

◼ Substitute Explanation: Hong Kong as a substitutes for the B-share market.

It is found when more H shares and red chips are listed in Hong Kong, the
B-share discount becomes Larger. (Sun and Tong 2000 JBF)

Fall 2023 YW(SHUFE) Chinese Stock Market 35

Who are the controllers of Chinese listed
companies?
◼ State and privately controlled manufacturing firms on Shanghai and
Shenzhen stock exchange 1999-2008 (Firth et al. 2012 JCF)

Fall 2023 YW(SHUFE) Chinese Stock Market 36

Privatization Benefit

◼ Motivation:
❑ Empirical evidence show that firm performance and value negatively related to
state ownership
❑ Synchronicity is higher when the largest shareholder is government related
(Gul, Kim and Qiu 2010 JFE)

◼ In China:
❑ Private ownership of listed firms in China is not necessarily superior to certain
types of state ownership (Chen, Firth and Xu 2009 JBF)

Fall 2023 YW(SHUFE) Chinese Stock Market 37

Privatization Benefit

◼ Ownership & earnings management, auditor, and audit fee:

❑ SOEs have lower incentive to manipulate earnings than NSOEs (Chen et al
2011 CAR)
❑ Lenders are less concerned with downside risk for SOEs than for NSOEs (Chen
et al. 2010 JAR)
❑ SOEs adopt less accounting conservatism than NSOEs (Chen et al 2010 JAR)
❑ Compared with NSOEs, local SOEs are more likely to hire small local auditors
(Wang, Wong and Xia 2008 JAE)
❑ SOEs incur less audit fees than NSOES, for lower bankruptcy risk brings lower
litigation risk for auditors (Liu and Subramaniam 2013 JAPP)

Fall 2023 YW(SHUFE) Chinese Stock Market 38

Agency Problem

◼ Type I agency problems arise from the separation of ownership and

management
◼ Type II agency problems arise from the conflicts of interest between
controlling and non-controlling shareholders

◼ In Chinese publicly traded firms due to the ownership structure, the

primary corporate governance problem is Type II agency problem
❑ Controlling shareholders use their control rights to expropriate wealth from
minority shareholders via various types of related party transactions

Fall 2023 YW(SHUFE) Chinese Stock Market 39

Agency Problem

◼ In Chinese publicly traded firms due to the ownership structure, the

primary corporate governance problem is Type II agency problem
❑ Controlling shareholders use their control rights to expropriate wealth from
minority shareholders via various types of related party transactions

◼ Peng, Wei and Yang 2011 JCF

❑ Statistics show that out of 719 listed firms in 1997, 84.6% were involved in
different degrees of connected transactions
❑ In 2000, 93.2%
❑ Among those connected transactions, more than 70% were conducted between
the controlling shareholders and their listed firms

Fall 2023 YW(SHUFE) Chinese Stock Market 40

How serious is the RPT problem?

◼ Lo, Wong, and Firth 2010 JCF

❑ Based on a sample of 266 publicly traded companies listed that disclosed their
gross profits on RPTs in 2004

Fall 2023 YW(SHUFE) Chinese Stock Market 41

RPT – Empirical Evidence

◼ Tunneling and Propping

❑ Tunneling refers to a transfer of resources from a firm to a another firm
❑ Propping refers a transfer in the opposite direction intended to bail out the
receiving firm from bankruptcy
◼ Tunneling through
❑ Abnormal related sales (Lo, Wong, and Firth 2010 JCF)
❑ Inter-corporate loans (Jiang, Lee and Yue 2010 JFE)
❑ Loan guarantee (Berkman, Cole, and Fu 2009 JBF)
◼ Controlling Shareholders
❑ Tunnel when their company are financially healthy, and prop when they are in
financial distress. (Peng, Wei and Yang 2011 JCF)
❑ Tunnel through abnormal related sales and prop through related lending (Jian
and Wang 2010 RAS)

Fall 2023 YW(SHUFE) Chinese Stock Market 42

Corporate Governance

◼ Independent directors
❑ Since 2001, CSRC required (1) listed firms should have 1/3 independent
directors; (2) the opinions of independent directors on important board decisions
be disclosed (Tang, Du and Hou 2013 JAPP find firms with more independent
directors saying “no” can help to protect the interests of outside investors.

◼ Disclosure
❑ Investors desire transparency in Chinese listed companies and reward
companies for more voluntary disclosure (Cheung, Jiang and Tan 2010 JAPP)

◼ Diversification and Firm value

❑ In China diversification has premium (Tobin’s Q) rather than discount, but the
extent of premium depends on ownership (Lin and Su 2008 JCF)

Fall 2023 YW(SHUFE) Chinese Stock Market 43

Corporate Governance – Institutional Investors

◼ Equity ownership by mutual funds (average<3%) has positive effect on

firm performance (Yuan, Xiao and Zou 2008 JBF)

◼ Institutional investors trade on their insider information during share-

structure reform (Tong, Zhang and Zhu 2013 JBF)

◼ Bank ownership associated with poorer operating performance via

inefficient investments (Lin, Zhang and Zhu 2009 JIMF)

Fall 2023 YW(SHUFE) Chinese Stock Market 44

Corporate Governance – Auditor Independence

◼ Auditor independence is influenced by regulatory shocks

❑ Auditing standard – reinforced after 1995

◼ Enhanced auditing standards, higher auditor independence

❑ Audit firm size – auditor mergers happen between 1999-2006

◼ Exogenous increase in audit firm size without increase in

competency, higher auditor independence
❑ Audit tenure – 2004 tenure fixed at 2-5 years

◼ Limited management influence on auditor’s opinion/choice

❑ Litigation risk

◼ 2002, private securities litigation rules by supreme people’s court,

higher auditor propensity to issue modified audit opinions

Fall 2023 YW(SHUFE) Chinese Stock Market 45

Litigation Risk is Increasing

◼ Directors and managers in China are required by CSRC to seek

shareholder’s approval for purchasing D&O insurance (Directors and
Officers Liability Insurance).

◼ Zou et al 2008 JBF identified 53 cases during 2000-2004 and found firms
with more acute controlling-minority shareholder incentive conflicts are
more likely to consider purchasing D&O insurance.

Fall 2023 YW(SHUFE) Chinese Stock Market 46

Corporate Governance – Other Monitors

◼ CSRC
❑ Enforcement actions of CSRC have a negative impact on stock prices

with most firms suffering wealth losses of around 1-2% in the 5 days
surrounding the event (Chen et al 2005 JAPP)

◼ Analysts
❑ Analyst coverage is positively associated with stock return

synchronicity measured by a firm’s R-square in China, but star analyst

coverage actually decreases stock return synchronicity (Xu et al 2013
JBF)
❑ Institutional investors pressure financial analysts through trading

commission fees to issue optimistic opinions in support of their stock

positions (Gu, Li and Yang 2013 TAR)

Fall 2023 YW(SHUFE) Chinese Stock Market 47

What Else?

◼ In China, access to equity market is a highly constrained process.

◼ Before 1999, a quota system was used
❑ Central government determines the overall size of the IPO market on a yearly
basis, each province received its IPO quota from and identified prospective
candidates based on applications by firms under its jurisdiction

◼ 2000-2004, a channel system was used

❑ Regulators assigned channels directly to sponsors, according to their size and
performance. Sponsors with channels recommended prospective firms to the
CSRC for an IPO

◼ 2005-present, a sponsorship system was used

❑ The sponsor recommends its client firms for an IPO listing, which must be
approved by the CSRC

Fall 2023 YW(SHUFE) Chinese Stock Market 48

Access to Equity Market

◼ State firms usually received priority for an IPO, whereas only a few private
entrepreneurial firms would be selected for listing

◼ Incentive to
❑ State companies
❑ Governments

Fall 2023 YW(SHUFE) Chinese Stock Market 49

Empirical Evidence

◼ IPO probability
❑ Higher probability of IPO, higher offering price, lower under-pricing (Francis,
Hasan, and Sun 2009 JIMF), and better post-IPO performance (Liu, Tang and
Tian 2013 JCF).

◼ Earnings Management before IPO

❑ Easier access to the equity market, thus less incentive to manage earnings to
increase their IPO chance (Aharony, Lee and Wong 2000 JAR)

Fall 2023 YW(SHUFE) Chinese Stock Market 50

Empirical Evidence

◼ Firm’s operating performance

❑ Firms underperform, because government bureaucrats makes the board
unprofessional (Fan, Wang, and Zhang 2007 JFE)
❑ Local SOEs with politically connected managers are prone to more severe over-
investment problems (Wu et al 2012 JAPP)

Fall 2023 YW(SHUFE) Chinese Stock Market 51

Empirical Evidence

◼ Market reaction
❑ When partially privatized firms’ announced proposed sales of remaining
government shares, stock market react negatively, than there is symmetric
positive reaction from the cancellation of such plan (Calomiris, Fisman and
Wang 2010 JFE). This suggests the benefits of political ties outweigh the
efficiency costs of government shareholdings.

◼ Acquirer’s returns
❑ Acquirers receive preferential treatment and acquire higher quality firms during
full privatization. However, they tend to tunnel the target firm after acquisition.

Fall 2023 YW(SHUFE) Chinese Stock Market 52

Empirical Evidence

◼ Politicians
❑ Politicians are rewarded for capital market activity. Career incentives of local
politicians can accelerate the pace of IPO activity in certain politicized
environments (Piotroski and Zhang 2013 JFE)

◼ Audit firms
❑ After their partners are appointed to the Stock Issuance Examination and
Verification Committee, non-top-tier audit firms significantly increase their IPO
audit fees and market share, and significantly reduce the IPO rejection risk for
their clients, whereas the same is not the case for top-tier audit firms. (Yang
2012 CAR)

Fall 2023 YW(SHUFE) Chinese Stock Market 53

Chinese Derivatives Market

◼ Exchanges:
❑ Shanghai Futures Exchange (SFE)
◼ 13 Metal Futures: copper, silver, gold, stainless steel, etc.
◼ 7 Energy/Chemical Futures: crude oil, asphalt, paper pulp, rubber, etc.
◼ 6 Options: crude oil, rubber, copper, gold, aluminum, zinc.

❑ Zhengzhou Commodity Exchange (ZCE)

◼ 14 Agricultural Futures: sugar, cotton, apple, peanut, etc.
◼ 9 Non-agricultural Futures: PTA, methanol, glass, coal, etc.
◼ 6 Options: sugar, cotton, PTA, coal, Methanol, Rapeseed meal.

Fall 2023 YW(SHUFE) Chinese Stock Market 54

Chinese Derivatives Market

◼ Exchanges:
❑ Dalian Commodity Exchange (DCE)
◼ 12 Agricultural Futures: corn, soybean meal, egg, pork, etc.
◼ 9 Energy/Chemical Futures: Ethylene Glycol, coking coal, hard coke, liquified
petroleum gas, etc.
◼ 8 Options: soybean meal, corn, liquified petroleum gas, Polyethylene, etc.
◼ 17 futures indices & 2 spot indices

❑ China Financial Futures Exchange (CFFE)

◼ CSI 300 index future
◼ CSI Smallcap 500 index future
◼ SSE 50 index future
◼ CSI 300 index option
◼ 2, 5, 10 year treasury futures

Fall 2023 YW(SHUFE) Chinese Stock Market 55

As an investor, what should we do?

◼ History and development of Chinese stock market

◼ Numbers, ratios
◼ Puzzles and potential problems
◼ Chinese financial derivatives market

◼ Imperfect market:
❑ Information asymmetry
❑ No strict de-listing rules
❑ Regulators
❑ Participants

Fall 2023 YW(SHUFE) Chinese Stock Market 56

As an investor, what should we do?

◼ Speculation or Investment?

◼ Policy Impact?

◼ Long Term Investment?

◼ Industry?
◼ Information Environment?
◼ Corporate Governance?
◼ Agency Problem?
◼ Share Structure?
◼ Market Capitalization?

Fall 2023 YW(SHUFE) Chinese Stock Market 57

Prospects

◼ Medium run: good economic fundamentals

◼ Stock market capitalization will expand faster than GDP
◼ IPO (first listing) & Chinese companies listing abroad returning home (dual
listing)
◼ Excess liquidity will continue to drive stock prices, but major corrections
will occur from time to time
◼ High volatility will remain, but may be mitigated in the future
◼ Linkage between the Chinese and other stock markets will grow

Fall 2023 YW(SHUFE) Chinese Stock Market 58

Open Questions

◼ Will a greater number of institutional investors have a stabilizing effect on

the Chinese stock market?

◼ Will a further opening-up of the Chinese stock market have a stablizing

effect?

◼ When will foreign companies list on the Chinese stock exchange?

Fall 2023 YW(SHUFE) Chinese Stock Market 59

 Thank you!

Fall 2023 YW(SHUFE) Chinese Stock Market 60