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Review of Quantitative Finance and Accounting

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01-08-2013 | Original Research

Corporate governance and market segmentation: evidence from the price difference between Chinese A and H shares

Authors: Lin Guo, Liang Tang, Shiawee X. Yang

Published in: Review of Quantitative Finance and Accounting | Issue 2/2013

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Abstract

This paper empirically examines whether the price difference between Chinese A shares, which are traded in the domestic market, and their matching H shares, which are traded in the Hong Kong market, can be explained by firms’ corporate governance characteristics. We find that the A- to H-share price premiums are higher for firms in which the controlling shareholders and corporate insiders have greater potential to expropriate wealth from outside investors. This result is robust when we use a variety of corporate governance variables specific to listed Chinese companies to explain the A-share price premiums and when we control for differences between domestic and foreign investors in required returns, degree of speculative trading, liquidity, information, and demand elasticity. Our findings highlight the important role of corporate governance in explaining the price difference in segmented stock markets.

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See Shleifer (1986) on evidence of downward sloping demand curve for stocks in the US market and Bailey (1994), and Sun and Tong (2000) for evidence in the markets of Chinese stocks.

We also examine the price differences between Chinese A shares and their matching ADRs on the NYSE, and the results are qualitatively similar. Because only seven firms have issued both A shares and NYSE ADRs, we only report our results from our A to H share comparisons.

See Peng et al. (2007) for a report on the price difference between dual-listed Chinese A and H shares.

China is not included in the studies of Leuz et al. (2009) and Giannetti and Simonov (2006).

Legal person shares in China are usually owned by domestic institutions, most of which are partially owned by the central or local government. However, it is possible that legal person shares are owned by privately owned companies.

Investors’ preference for local stocks has been a well-documented characteristic of international equity portfolios (see French and Poterba 1991 and others). Xu and Fung (2002) also provide evidence that Hong Kong market information plays a greater role in information transmission than the New York market for China-backed stocks that are dual-listed in Hong Kong and New York.

Huang and Fung (2005) suggest that there was not an active market for corporate control in China because mergers and acquisitions could hardly increase values of non-tradable controlling shareholders.

Bai et al. (2004) use a dummy variable on whether the CEO is the chairman or the vice chairman of the board of directors to proxy for the effectiveness of the monitoring role from the board. However, we do not have information on whether the CEO is a vice chairman from the PACAP Corporate Governance database.

Hietala (1989) uses market models to estimate the betas of the restricted and unrestricted stocks of Finnish companies and then tests whether the premium of the unrestricted stock is because of foreign investors’ lower required rate of return.

These regression specifications are close to those of Wang and Jiang (2004). They regress daily returns of A-share (H-share) returns on Chinese mainland stock market index returns, Hong Kong market index returns (Hang Seng Index returns), and the percentage change in the exchange rate between RMB and Hong Kong dollars. The coefficients on the change of exchange rate are mostly insignificant in their regressions.

To test whether investor sentiment plays a role in the US-traded closed-end foreign country fund premium, Bodurtha et al. (1995) estimate a time-series regression of the changes in the closed-end foreign country fund premiums on a global market index, US market returns, exchange rate changes, and a domestic closed-end fund premium index. They interpret a significantly positive coefficient on the US market returns as evidence that supports the investor sentiment hypothesis.

None of the 31 cross-listed firms in our sample issued B shares.

A-share (or H-share) daily turnover is defined as the ratio of A-share (or H-share) daily trading volume to the number of A (or H) shares outstanding.

See Sun and Tong (2003) on a discussion of this potential negative role of legal person ownership. However, they find a positive relation between a Chinese firm’s legal person ownership and its profitability after share-issue privatization.

Bai et al. (2004) include the ownership of the largest shareholder and the square of this variable in their Tobin’s q regression to allow for a non-linear relation between Tobin’s q and the ownership of the largest shareholder.

The results from Su (1999) also suggest that foreign investors require higher expected returns on Chinese B shares than on Chinese A shares.

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Title: Corporate governance and market segmentation: evidence from the price difference between Chinese A and H shares
Authors: Lin Guo
Liang Tang
Shiawee X. Yang
Publication date: 01-08-2013
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 2/2013
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-012-0313-0

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