Float, Liquidity, Speculation, and Stock Prices: Evidence froFloat, Liquidity, Speculation, and Stock Prices: Evidence from the Share Structure Reform in Chinam the Share Structure Reform in China

Hwang Chuan Yang Hwang Chuan Yang Nanyang Business SchoolNanyang Business School

Zhang Shaojun Zhang Shaojun Nanyang Business SchoolNanyang Business School

Zhu Yanjian Zhu Yanjian Nanyang Business SchoolNanyang Business School

2006 NTU International Conference on Finance2006 NTU International Conference on FinanceDecember 14, 2006December 14, 2006

Motivations Internet Bubble. Between early 1998 till Feb. 2000, internet sect

or prices rose over 1000%, then it collapsed in April 2000. Ofek and Richardson (2003), Cochrane (2003), Hong, Scheink

man and Xiong (2006) offer explanations. Investors have diverse views and the sector tend to have rel

atively more individual investors. Short-sale constraints (Miller (1977), Chen,Hong and Stein

(2002)) Shares are in short supply Lock-up provisions for insiders’ shares

Chinese share markets have all of these features and its split share reform provides an ideal setting for conducting out-of-sample and outside-the US market tests.

Chinese Split Share Reform Background 1 Features of China Market

Two markets: A- and B-share markets Split-share structure: 1/3 Tradable and 2/3 non-tradable

A-shares mostly owned by state owned enterprises Undesirable effect of the split share structure are that

managers don’t maximize shareholders values and that it makes take-over and merger activities impossible

Share structure reform: On April 29, 2005, the government announced a reform plan to abolish the split-share structure

Chinese Split Share Reform Background 2 Making all previous non-tradable shares tradable Non-tradable shareholders pay a consideration to tradable

shareholders to exchange for the liquidity of their shares; an early reform failed in which tradable shareholders were not paid

Non-tradable Shareholders

TradableShareholders

Additional value from improved liquidity

Consideration received

Consideration paid

Chinese Split Share Reform Background 2Steps in implementing the reform:

Bonus shares immediately tradable; lock up period for other shares.

Full Name BEIJING TONGRENTANG CO., LTD

Security Short Name TongRenTang

Security Code 600085

List Exchange Shanghai Stock Exchange

Major Products Traditional Chinese medicine and cosmetic

Share Structure Reform Process

Date Milestone Share Price

(RMB)

Start of restructuring

(D0) 2005-10-15

Share structure reform announced; Non-tradable and tradable shareholders held

64.19% (state-owned) and 35.81% of total shares respectively.

20.38

2005-10-17

Share trading suspended; Draft reform plan published; Non-tradable shareholders pay tradable

shareholders 0.22 shares for every share held by tradable shareholders.

First trading suspension

period

2005-10-26

Revised reform plan confirmed; Non-tradable shareholders pay tradable

shareholders 0.25 shares for every share held by tradable shareholders.

D1 2005-10-27 Share trading resumed 19.90

D2 2005-11-10 Rights of receiving the bonus shares recorded 19.92

2005-11-11 Share trading suspended

2005-11-18 Online voting starting

2005-11-22 Online voting ending Second trading

suspension period

2005-11-25

Plan implemented; Non-tradable and tradable shareholders held

55.24% (state-owned) and 44.76% of total shares

End of restructuring

(D3) 2005-11-30

Share trading resumed; All shares held by tradable shareholders,

including the bonus shares received, can be traded freely;

All shares held by non-tradable shareholders can be traded only after 1, 2, or 3 years.

15.40

Our Contributions to the Literatures

Speculative Bubbles

Ofek and Richardson (2003), Cochrane (2003), Hong, Scheinkman and Xiong (2006): diverse beliefs, short-sale constraint and limited supply have contributed to the internet bubble.

Would the same factors lead to speculative bubbles in other markets?

It is much harder to detect speculative bubbles without seeing the bubbles collapse. With the data from split share reform, we show there is bubble in the Chinese share market.

We show that split share reform has dampened speculation. Furthermore, we show that price drop and the decrease in speculative activity is larger for more speculative firms.

Our Contributions to the Literatures

Shape of Demand Curves

Scholes (1972): there are perfect substitutes for assets hence demand curve is horizontal (perfectly elastic).

Harries Gruel (1996), Shleifer (1996), Lynch and Mendenhall (1997): Prices rise when stocks are added S&P 500 index indicating demand curve is downward sloping.

Field and Hanka (2001), Ofek and Richadson (2000): When the IPO lock-up provisions expire, stock price drops indicating demand curve is downward slopping.

These results can be contaminated by information. Our tests are based on a regulatory change which should be f

ree of information content.

Our Contributions to the Literatures

Liquidity Premium

Silber (1991), Longstaff (1995): Restricted shares are traded at price discount relative to unrestricted shares.

Amihud and Mendelson (1991), Naik & Radcliffe (1998), Brennen, Chordia and Subrahmanyam (1998): Stocks with better liquidity are traded at higher prices hence lower expected return.

We show that the price difference between tradable and non-

tradable is larger for more liquid stocks indicating the liquidity is priced.

We show that firm values increase after the reform due to improved liquidity and the increase in firm value is larger for firms with larger improvement in liquidity.

Our Contributions to the Literatures

Chinese Stock Markets

Allen,Qian and Qian (2006): Law and economic growth.

B share discount: Illiquidity (Chen and Xiong (2001)); Market momentum (Karolyi and Li (2003)); Information asymmetry (Chan, Menkveld and Yang (2006)); Speculation (Mei,Scheinkman and Xiong (2005)).

We show that split share reform has dampened speculation and improved liquidity in Chinese stock markets.

B share price discount decreases after the reform: smaller speculation lowers A share prices while B share prices rise due to liquidity improvement.

Data

Information about share restructuring, ROA and ROE for the fiscal year ending on December 31, 2004: www.cninfo.com.cn

Stock price and trading volume: Bloomberg Till Mar. 25, 2006, 509 firms started the share structure

reform. 31 firms are still in the process of reform. 89 firms adopted a consideration package that is more complex than a simple consideration of bonus shares. IPO firms in the year before Mar. 25, 2006 and those firms whose price data are not available from Bloomberg terminal are also excluded. Final sample: 309 firms.

MethodologyMethodology - - Calculation of price premium and wealth gainCalculation of price premium and wealth gain

Relate the price premium of tradable shares relative to Relate the price premium of tradable shares relative to non-tradable share to the consideration paid by non-non-tradable share to the consideration paid by non-tradable shareholders to tradable shareholderstradable shareholders to tradable shareholders

EquationsEquations

1 2 1 10 2 20( ) ( )Z N N P N P N P

101211 )( PNPNbNZ

202222 )( PNPNbNZ

)()( 20210121 PNPNPNNZ

MethodologyMethodology- Continued- Continued

Model Assumption: Model Assumption: Total gain is shared by non-tradable and tradable Total gain is shared by non-tradable and tradable

shareholders in proportion to the number of shares they shareholders in proportion to the number of shares they own after reformown after reform

ZNN

NbNZ

21

211

ZNN

NbNZ

21

222

20 10

10

P PL

P

baba

bL

202121 )1()( PNLNPNNZ

202

201010 )1()1()1()1( PabPaaPaabPaa

Methodology- Continued

We use one-year average of the daily dollar trading volume prior to the reform to proxy for the degree of speculative activity. Mei, Scheinkman and Xiong (2005) use daily turnover.

We use the proportion of no-price-change days of a stock over one-year period prior to the reform (Lesmond, Ogden and Trzcinka (1999)) as a measure of liquidity. Bekaert, Harvey and Lundbald (2003) has found this measure particularly useful in emerging markets.

Table 3: Descriptive Statistics

Table 4: Liquidity Premium and Speculation Component in Tradable Share Prices

Model 1 2 3 4

Intercept 0.22 0.92

-0.19 -0.47

0.20 0.87

-0.21 -0.52

ROE -0.28b -2.17

-0.24c -1.90

ROA -0.41c -1.93

-0.35c -1.69

Return Volatility

-5.74 -1.55

-2.23 -0.62

-5.57 -1.50

-2.06 -0.57

ln(Volume) 0.03b 2.45

0.03b 2.43

ln(Market Cap)

0.04b 2.21

0.04b 2.23

Percentage of Zero Return

-1.45b -1.95

-1.58b -2.21

-1.50b -1.99

-1.62b -2.24

1/Price 0.62a 3.28

0.64a 3.31

0.65a 3.36

0.67a 3.38

Dummy -0.13a -5.17

-0.13a -4.90

-0.12a -5.05

-0.12a -4.81

Adj. R2 0.11 0.119 0.10 0.11 # of obs. 309 309 309 309

Table 5:Impact on Turnover

Speculative Trading

Test Stat.

High Low Sub-total

High vs Low Speculation

# of obs. 87 61 148 Mean -1.028 1.370 -0.039 -2.76a High Median -0.068 1.238 0.239 -3.32a # of obs. 61 87 148 Mean 0.557 0.964 0.796 -0.91

Liquidity

Low Median 0.388 0.923 0.768 -1.99b # of obs. 148 148 296 Mean -0.375 1.131 -3.05a Sub-total Median 0.136 0.968 -4.01a

Mean -2.14b 0.80 -1.67c Test Stat.

High vs Low Liquidity Median -1.81 0.18 -1.72c

Table 6: Impact on Speculative Trading

Speculative Trading

Test Stat.

High Low

Sub-total

High vs Low Speculation

# of obs. 87 61 148 Mean -0.330 1.921 0.597 -3.98a High Median -0.054 1.581 0.550 -3.70a # of obs. 61 87 148 Mean 0.738 1.458 1.162 -1.33

Liquidity

Low Median 0.670 1.443 0.916 -2.21a # of obs. 148 148 296 Mean 0.110 1.649 -3.75a Sub-total Median 0.204 1.475 -4.29a

Mean -1.79c 0.80 -1.35 Test Stat.

High vs Low Liquidity Median -1.45 0.33 -1.24

Table 7: Impact on Price and the Downward Sloping Demand Curve

Speculative trading Test Stat.

High Low Sub-total High vs Low speculation

# of obs. 90 65 155 Mean -14.01% -8.70% -11.78% -1.83c High Median -14.54% -11.81% -13.20% -1.90c # of obs. 64 90 154 Mean -16.68% -10.54% -13.09% -2.10b

Liquidity

Low Median -19.64% -13.05% -15.76% -2.56a # of obs. 154 155 309 Mean -15.12% -9.77% -2.59a Sub-total Median -17.16% -12.58% -2.89a Mean 0.81 0.70 0.63

Test Stat. High vs Low Liquidity Median 1.14 0.79 0.91

Table 8: Further Evidence of the Downward Sloping Demand Curve

Model 1 2 3 4

Intercept -0.13a -12.06

-0.13a -12.08

-0.13a -12.12

-0.13a -12.14

b -0.46a -2.57

-0.48a -2.72

-0.46a -2.55

-0.48a -2.69

ROE -0.14 -1.14

-0.18 -1.43

ROA -0.24 -1.08

-0.30 -1.37

Return Volatility 1.32 0.46

-2.37 -0.76

1.36 0.47

-2.30 -0.74

Ln(Volume) -0.03a -2.68

-0.03a -2.65

Ln(Market Cap) -0.04a -3.01

-0.04a -2.99

Percentage of Zero Return

-1.09 -1.33

-0.97 -1.21

-1.11 -1.37

-0.99 -1.25

1/P 0.09 0.53

0.06 0.39

0.09 0.60

0.07 0.46

Dummy 0.05 1.18

0.04 1.08

0.05 1.30

0.05 1.22

Adj. R2 0.04 0.04 0.04 0.04 # of obs. 309 309 309 309

Table 9: Impact on Shareholder Wealth

Speculative Trading Test Stat.

High Low

Sub-total

High vs Low Speculation

# of obs.

90 65 155

Mean 13.29% 21.07% 16.56% -2.02b High

Median 12.07% 16.93% 14.95% -2.16b # of obs.

64 90 154

Mean 7.01% 17.36% 13.06% -2.85a

Liquidity

Low

Median 3.11% 14.37% 10.86% -3.09a # of obs.

154 155 309

Mean 10.68% 18.91% -3.07a Sub-total

Median 7.83% 15.69% -3.39a Mean 1.50 1.11 1.29

Test Stat. High vs Low

Liquidity Median 1.57 1.05 1.33

Table 10: Wealth Gain and Liquidity Improvement

Raw wealth gain (price 30

days later) Raw wealth gain (price of

the first day) Model 1 2 3 4 5 6

Intercept 0.13a 7.33

0.03a 1.84

0.22a 10.17

0.10a 6.05

0.02a 1.22

0.17a 9.28

Change in Turnover 4.75a 4.84

2.98a 3.31

Change in Dollar Volume

0.19a 10.02

0.14a 8.63

Change in Percentage of zero

returns

-2.59a -3.88

-2.24a -4.06

ln(Volume) -0.04 b -2.45

0.01 0.73

-0.03 -1.56

-0.03b -2.35

0.00 0.21

-0.03 -1.31

Dummy 0.07 1.11

0.07 1.17

0.08 0.93

0.07 1.26

0.07 1.33

0.09 1.13

1/P 0.05 0.30

-0.05 -0.30

0.61b 2.40

0.09 0.60

0.01 0.07

0.54b 2.32

Adj. R2 0.084 0.232 0.115 .057 0.184 0.116 # of obs. 309 309 188 309 309 188

Table 11: Impact on B Share Market

Panel A. Change in turnover and share price in the B-share market

Panel B. Change in B-Share Discount

Change in turnover Change in price

Restructured Control Test Stat.

Restructured Control Test Stat.

# of obs. 27 32 27 32 Mean 169.69% 73.93% 2.06b 21.90% 10.86% 1.49

Median 132.12% 53.99% 2.08b 18.86% 6.25% 1.59 Std. Dev. 229.67% 80.57% 28.67% 28.05%

Min. -62.52% -41.70% -25.48% -31.13% Q1 29.78% 17.89% -0.86% -9.22% Q3 229.34% 117.68% 45.86% 30.44%

Max. 1142.03% 308.54% 77.33% 79.71%

Before the Reform After the Reform

Restructured Control Test Stat.

Restructured Control Test Stat.

# of obs. 27 32 27 32 Mean 43.79% 43.07% 0.17 30.31% 43.45% -3.13a

Median 44.73% 44.71% 0.11 29.32% 42.66% -2.78a

Std. Dev. 14.97% 16.82% 15.99% 16.14% Min. 12.58% 4.06% 1.21% 1.38% Q1 35.63% 35.30% 17.78% 36.59% Q3 57.85% 55.53% 44.34% 57.59%

Max. 63.95% 68.60% 56.70% 69.50%

Conclusions There is a speculative bubble in the Chinese stock markets. This is consistent with

the explanation for the internet bubble in the NASDAQ market: diverse views of individual investors, short-sale constraint and limited share supply.

Chinese split share reform is successful. By increasing the share supply, Chinese split share reform has dampened speculation and improved liquidity.

The reduction in speculation is greater for stocks with greater speculation before the reform.

The improvement in liquidity is larger for less speculative stocks. B share discount is reduced significantly after the reform; A share price drops while B

share price increases even though the reform does not involve B shares. Despite of the price drop of the tradable share, shareholder wealth (firm value)

increases after the reform, and the increase is positively related to the liquidity improvement.

Demand curve is clearly downward sloping.