Float, Liquidity, Speculation, and Stock Prices:
Evidence from the Share Structure Reform in China
Hwang Chuan Yang
Nanyang Business School
Zhang Shaojun
Nanyang Business School
Zhu Yanjian
Nanyang Business School
2006 NTU International Conference on Finance
December 14, 2006
Motivations
 Internet Bubble. Between early 1998 till Feb. 2000, internet
sector prices rose over 1000%, then it collapsed in April 2000.
 Ofek and Richardson (2003), Cochrane (2003), Hong,
Scheinkman and Xiong (2006) offer explanations.
 Investors have diverse views and the sector tend to have
relatively 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-ofsample 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 Ashares 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
Additional value from improved liquidity
Non-tradable
Shareholders
Tradable
Shareholders
Consideration received
Consideration paid
Chinese Split Share Reform
Background 2
Steps 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
Start of
restructuring
(D0)
2005-10-15
Milestone


Share structure reform announced;
Non-tradable and tradable shareholders held
64.19% (state-owned) and 35.81% of total
shares respectively.
Share trading suspended;
Draft reform plan published;
Non-tradable shareholders pay tradable
shareholders 0.22 shares for every share held
by tradable shareholders.
Revised reform plan confirmed;
Non-tradable shareholders pay tradable
shareholders 0.25 shares for every share held
by tradable shareholders.
Share Price
(RMB)
20.38
2005-10-17



2005-10-26


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
2005-11-25


Plan implemented;
Non-tradable and tradable shareholders held
55.24% (state-owned) and 44.76% of total
shares
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.
First trading
suspension
period
Second
trading
suspension
period
End of
restructuring
(D3)


2005-11-30

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
free 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 nontradable 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.
Methodology
- Calculation of price premium and wealth gain
Relate the price premium of tradable shares relative to
non-tradable share to the consideration paid by nontradable shareholders to tradable shareholders

Equations
Z  ( N11  N
N22))  P  ( N
N11  PP1010  N
N22  P
P2020))
Z1  ( N1  b  N 2 )  P  N1  P10
Z 2  ( N 2  b  N 2 )  P  N 2  P20
Methodology- Continued

Model Assumption:
Total gain is shared by non-tradable and tradable shareholders
in proportion to the number of shares they own after
reform
Z1 
Z2 
N1  b  N 2
Z
N1  N 2
 a  (1  a)  P10  b  a  (1  a)  P10  a  (1  a)  P20  b  (1  a) 2  P20
N2  b  N2
Z
N1  N 2
L
L
P20  P10
P10
b
a  b  a b
Z  ( N1  N 2 )  P  N1 (1  L)  N 2  P20
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
Intercept
ROE
1
0.22
0.92
-0.28b
-2.17
2
-0.19
-0.47
-0.24c
-1.90
ROA
Return
Volatility
ln(Volume)
ln(Market
Cap)
Percentage of
Zero Return
1/Price
Dummy
Adj. R2
# of obs.
-5.74
-1.55
0.03b
2.45
-1.45b
-1.95
0.62a
3.28
-0.13a
-5.17
0.11
309
-2.23
-0.62
0.04b
2.21
-1.58b
-2.21
0.64a
3.31
-0.13a
-4.90
0.119
309
3
0.20
0.87
4
-0.21
-0.52
-0.41c
-1.93
-5.57
-1.50
0.03b
2.43
-0.35c
-1.69
-2.06
-0.57
-1.50b
-1.99
0.65a
3.36
-0.12a
-5.05
0.10
309
0.04b
2.23
-1.62b
-2.24
0.67a
3.38
-0.12a
-4.81
0.11
309
Table 5:Impact on Turnover
Speculative
Trading
High
# of obs.
High
Mean
Median
Liquidity
# of obs.
Low
Mean
Median
# of obs.
Sub-total Mean
Median
High vs Mean
Test Stat. Low
Liquidity Median
Test Stat.
Low
87
-1.028
-0.068
61
0.557
0.388
148
-0.375
0.136
-2.14b
61
1.370
1.238
87
0.964
0.923
148
1.131
0.968
0.80
-1.81
0.18
High vs
Sub-total Low
Speculation
148
-0.039
-2.76a
0.239
-3.32a
148
0.796
-0.91
0.768
-1.99b
296
-3.05a
-4.01a
-1.67c
-1.72c
Table 6: Impact on Speculative Trading
Speculative
Trading
High
# of obs.
High
Mean
Median
Liquidity
# of obs.
Low
Mean
Median
# of obs.
Sub-total Mean
Median
High vs Mean
Test Stat. Low
Liquidity Median
87
-0.330
-0.054
61
0.738
0.670
148
0.110
0.204
-1.79c
-1.45
Test Stat.
Low
61
1.921
1.581
87
1.458
1.443
148
1.649
1.475
0.80
High vs
SubLow
total
Speculation
148
-3.98a
0.597
-3.70a
0.550
148
-1.33
1.162
-2.21a
0.916
296
-3.75a
-4.29a
-1.35
0.33 -1.24
Table 7: Impact on Price and the Downward
Sloping Demand Curve
Speculative trading
High
High
Liquidity
Low
Sub-total
Test Stat.
High vs Low
Liquidity
# of obs.
Mean
Median
# of obs.
Mean
Median
# of obs.
Mean
Median
Mean
Median
90
-14.01%
-14.54%
64
-16.68%
-19.64%
154
-15.12%
-17.16%
0.81
1.14
Low
65
-8.70%
-11.81%
90
-10.54%
-13.05%
155
-9.77%
-12.58%
0.70
0.79
Test Stat.
High vs Low
Sub-total
speculation
155
-11.78%
-1.83c
-13.20%
-1.90c
154
-13.09%
-2.10b
-15.76%
-2.56a
309
-2.59a
-2.89a
0.63
0.91
Table 8: Further Evidence of the Downward Sloping
Demand Curve
Model
Intercept
b
ROE
1
-0.13a
-12.06
-0.46a
-2.57
-0.14
-1.14
2
-0.13a
-12.08
-0.48a
-2.72
-0.18
-1.43
ROA
Return Volatility
Ln(Volume)
1.32
0.46
-0.03a
-2.68
Ln(Market Cap)
Percentage of Zero
Return
1/P
Dummy
Adj. R2
# of obs.
-1.09
-1.33
0.09
0.53
0.05
1.18
0.04
309
-2.37
-0.76
-0.04a
-3.01
-0.97
-1.21
0.06
0.39
0.04
1.08
0.04
309
3
-0.13a
-12.12
-0.46a
-2.55
4
-0.13a
-12.14
-0.48a
-2.69
-0.24
-1.08
1.36
0.47
-0.03a
-2.65
-0.30
-1.37
-2.30
-0.74
-1.11
-1.37
0.09
0.60
0.05
1.30
0.04
309
-0.04a
-2.99
-0.99
-1.25
0.07
0.46
0.05
1.22
0.04
309
Table 9: Impact on Shareholder Wealth
Speculative Trading
High
# of
obs.
High
Mean
Median
Liquidity
# of
obs.
Low
Mean
Median
# of
obs.
Sub-total
Mean
Median
High vs Low Mean
Test Stat.
Liquidity Median
Low
90
13.29%
12.07%
64
7.01%
3.11%
65
Test Stat.
Subtotal
155
21.07% 16.56%
16.93% 14.95%
90
155
10.68%
7.83%
1.50
1.57
18.91%
15.69%
1.11
1.05
-2.02b
-2.16b
154
17.36% 13.06%
14.37% 10.86%
154
High vs Low
Speculation
-2.85a
-3.09a
309
-3.07a
-3.39a
1.29
1.33
Table 10: Wealth Gain and Liquidity Improvement
Model
Intercept
Change in Turnover
Change in Dollar
Volume
Change in
Percentage of zero
returns
ln(Volume)
Dummy
1/P
Adj. R2
# of obs.
Raw wealth gain (price 30
days later)
3
2
1
0.22a
0.03a
0.13a
10.17
1.84
7.33
4.75a
4.84
0.19a
10.02
Raw wealth gain (price of
the first day)
6
5
4
0.17a
0.02a
0.10a
9.28
1.22
6.05
2.98a
3.31
0.14a
8.63
-2.59a
-3.88
-2.24a
-4.06
-0.04 b
-2.45
0.07
1.11
0.05
0.30
0.084
309
0.01
0.73
0.07
1.17
-0.05
-0.30
0.232
309
-0.03
-1.56
0.08
0.93
0.61b
2.40
0.115
188
-0.03b
-2.35
0.07
1.26
0.09
0.60
.057
309
0.00
0.21
0.07
1.33
0.01
0.07
0.184
309
-0.03
-1.31
0.09
1.13
0.54b
2.32
0.116
188
Table 11: Impact on B Share Market
Panel A. Change in turnover and share price in the B-share market
Change in turnover
# of obs.
Mean
Median
Std. Dev.
Min.
Q1
Q3
Max.
Restructured
Control
27
169.69%
132.12%
229.67%
-62.52%
29.78%
229.34%
1142.03%
32
73.93%
53.99%
80.57%
-41.70%
17.89%
117.68%
308.54%
Change in price
Test
Stat.
2.06b
2.08b
Restructured
Control
27
21.90%
18.86%
28.67%
-25.48%
-0.86%
45.86%
77.33%
32
10.86%
6.25%
28.05%
-31.13%
-9.22%
30.44%
79.71%
Test
Stat.
1.49
1.59
Panel B. Change in B-Share Discount
Before the Reform
# of obs.
Mean
Median
Std. Dev.
Min.
Q1
Q3
Max.
Restructured
Control
27
43.79%
44.73%
14.97%
12.58%
35.63%
57.85%
63.95%
32
43.07%
44.71%
16.82%
4.06%
35.30%
55.53%
68.60%
After the Reform
Test
Stat.
0.17
0.11
Restructured
Control
27
30.31%
29.32%
15.99%
1.21%
17.78%
44.34%
56.70%
32
43.45%
42.66%
16.14%
1.38%
36.59%
57.59%
69.50%
Test
Stat.
-3.13a
-2.78a
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.