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Corporate ownership, equity risk and returns in the People's Republic of China

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Abstract

A large body of literature has examined how managerial ownership affects corporate strategy and risk-taking. The present study extends this literature by investigating the effect of other forms of corporate ownership on a firm’s equity risk (measured as the volatility of a company’s stock returns) and stock returns in the People’s Republic of China (PRC) – an important emerging economy that is rich in various forms of corporate ownership. We find that the various types of corporate ownership appear to have important but different impacts on equity risk and returns. In particular, companies with more state ownership tend to have higher stock volatility and lower stock returns; in contrast, companies with more legal-person ownership tend to have lower stock volatility and higher stock returns. Foreign and managerial ownership are found to have little effect on firms’ equity risk and returns. These findings support the predictions of agency theory – for example, that state ownership increases agency conflicts in companies because bureaucrats and state agencies do not have the same economic incentives to maximize the value of firms. We believe that our study contributes to the international business literature on investment strategy and risk assessment in developing markets such as China, and as a result our findings could have important implications for international investors.

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Notes

  1. These details are correct for our sample period, 1996–2000. The Chinese government made the trading of B-shares available to domestic investors in February 2001 and the trading of A-shares available to QFIIs in December 2002.

  2. Recent studies (e.g., Tian, 2001) investigating the influence of state ownership on financial performance in the Chinese corporate sector have attempted to trace the ultimate source of ownership. However, the results obtained from using such proprietary ownership data are generally no different from those obtained using publicly available ownership data under official classifications. Furthermore, we do not use ultimate ownership data in our study because, in China, ultimate ownership data are often private information and therefore not normally available to the investment community. Investors (including foreign investors) therefore have to rely mainly on publicly available information rather than inside information to make investment decisions.

  3. Xu and Wang (1999) further suggest that the inactive nature of small shareholders (like investors of tradable A-shares) makes legal persons a more powerful shareholder group in corporate affairs than their equity stake at first sight suggests.

  4. Poon et al. (1998) report that, compared with A-share markets, the trading in B-share markets is relatively thin. This may to some extent limit the ability to trade large numbers of B-shares.

  5. In China, each individual investor is prohibited from holding more than 0.5% of the total value of shares in issue of any PLC.

  6. We perform a cross-sectional analysis on the basis of individual securities rather than at a portfolio level. We acknowledge that, if the analysis was conducted at a portfolio level, the possible downward bias in the estimated coefficients that arises from measurement errors at individual level might be mitigated if individual shares were not perfectly correlated (e.g., Comiskey, Mulford, & Porter, 1986). However, this would come at the expense of a loss of information and a reduction in degrees of freedom, thereby hampering our ability to identify and analyze cross-sectional differences in our (short) time-series data set (Chung & Charoenwong, 1991). Additionally, Hill and Stone (1980) note that portfolio groupings, while reducing measurement error from individual securities, might introduce aggregation bias. As a result, Lee and Forbes (1980: 214) argue that cross-sectional modeling using individual securities generally produces more robust results than time-series modeling using portfolios of securities. Moreover, we consider that a priori the use of a fixed-effects model could help to mitigate data measurement errors (e.g., due to omitted variables).

  7. As noted in “Institutional Background”, share price volatility in the PRC varies between shares held by domestic investors (A-shares) and those held by foreign investors (B-shares). The daily returns for the 50 or so companies that issue both A-shares and B-shares in the period of analysis were computed from the value-weighted average of daily returns of A- and B-shares. The SHSE and SZSE A-share indices were chosen as the market index for A-share companies in these two markets, respectively. Also, the SHSE and SZSE composite indices (which include both A-share and B-share companies) were chosen as the market index for companies with both A- and B-shares in the two markets.

  8. A Wald test and Lagrange LM test support the use of a panel model as being superior to a pooled OLS estimator. A Hausman test and Baltagi-Li LM test are statistically significant at the 0.05 level or better (two-tailed), supporting the use of a fixed-effect estimator.

  9. The non-publicly tradable large blocks of shares held by the state and institutional investors can be transferred through negotiations, subject to government approval, when state-held shares are involved. A common practice is to transfer such shares at prices based on the book value of net assets per share plus a margin for traders’ profit and expenses.

  10. In the present study we scaled subsidies by sales income rather than taxable profit, because annual reported taxable profit can be negative.

  11. The effect of these relaxations in trading rules and the emergence of institutional investors (e.g., domestic mutual funds, QFIIs) in recent years on firms’ equity risk and returns serve as an interesting topic for future research.

  12. China practiced a quota allocation control on share issues until 2001.

  13. Fixed-effect models cannot be estimated because industry dummies are time-invariant.

  14. DFFITS i =(h ii /1−h ii )1/2 × u i ,, where u i is the ith (studentized) deleted residual, and h ii is the ith diagonal term of the hat matrix. The (studentized) deleted residual is the standardized residual for a case when the case is excluded from the computation of the regression statistics. For details, see Maddala (1992: 487).

  15. Unreported results are available from the authors.

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Acknowledgements

The comments of Mike Buckle, Philip Hardwick, David Hillier, Clive Lennox, Sonia Wong, Jason Xiao, Tong Yu, and Steven Young on earlier versions of this paper are appreciated. The paper also benefited from the suggestions of participants at the 2002 Cardiff University Chinese Economy Research Seminar, the 2002 University of Wales’ Accounting and Finance Colloquia, Gregynog, the 2002 Chinese Economic Association (CEA) Conference in London, and a seminar organized by the Department of Business Administration, University of Umeå, Sweden. An early version of the paper was awarded the best paper prize at the 2002 CEA meeting. We are also grateful for the helpful suggestions of two anonymous referees and Professor Lee H. Radebaugh (Departmental Editor). However, the usual disclaimer applies.

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Correspondence to Hong Zou.

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Accepted by Lee Radebaugh, Departmental Editor, 18 July 2007. This paper has been with the authors for two revisions.

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Zou, H., Adams, M. Corporate ownership, equity risk and returns in the People's Republic of China. J Int Bus Stud 39, 1149–1168 (2008). https://doi.org/10.1057/palgrave.jibs.8400394

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