Until recently, Chinese companies publicly listed in domestic stock exchanges had two classes of stock: tradable and non-tradable shares. These two classes of stock had the same voting, cash flow, and all other legal rights except that non-tradable shares cannot be transferred at the open markets. From 2005 to mid-2007, Chinese government completed the ownership reform, so-called the Split Share Structure Reform (SSSR), to convert all non-tradable shares into tradable shares. Under this reform process, the holders of non-tradable shares had to negotiate with those of tradable shares to determine how much liquidity premium, or the compensation ratio, non-tradable shareholders have to pay to tradable shareholders in order to obtain the liquidity right. This paper starts with a theoretical model to identify the fundamental factors, including price discount before and after the SSSR reform, the percentage of non-tradable shares in total shares, the volatility of tradable share price, and the lockup period, that should determine the compensation ratio. We show that those factors except price discount before the reform are statistically significant in determining the compensation ratio proposed by non-tradable shareholders. We further show that the agency problems also reveal themselves in the compensation ratios. Specifically, when a firm is controlled by a governmental agency, the compensation is higher. However, the compensation is lower when more concentrated in the top ten holders, especially when shares are held by mutual funds. Thus, the evidence is consistent with the notion that the agency problem exists in China’s fund managers. Finally, we show that the existence of agency problems also reduce the importance of fundamental factors in determining the compensation ratios.

A fundamental question in finance is whether and how removing market frictions is associated with efficiency gains. We study this question using share issue privatization in China that took place through the split share structure reform. Prior to the reform, domestic A-shares were divided into tradable and non-tradable shares with identical cash flow and voting rights. Under the reform, holders of the non-tradable shares negotiated a compensation plan with holders of the tradable shares in order to make their shares tradable. We hypothesize that efficiency gains in terms of better risk sharing play an important role in the determination of compensation. We show that the size of compensation is positively associated with both the gain in risk sharing and the price impact of more shares coming to the market after the reform, and is negatively associated with the bargaining power of holders of non-tradable shares and firm performance. Our study highlights the role of risk sharing in China’s share issue privatization.

Existing literatures indicate that, in Nontradable Shares Reform, institutional investors collude with nontradable shareholders (controlling shareholders) to help them settle a lower compensation ratio. Classifying institutional investors into mutual funds and non-mutual funds, this paper presents a further research upon whether fund governance helps mitigate collusion. Due to the rigorous entry qualifications, and the worldwide reputation as hostage, a foreign background fund is expected to have better governance quality than a domestic fund. Our empirical evidence shows that, relative to those dominated by domestic funds, mutual funds dominated by foreign background funds are less inclined to collude with nontradable shareholders. Introducing foreign institutional investors into domestic markets is Chinese government’s consistent policy. Our evidence indicates that this policy may be beneficial to the sound development of Chinese stock markets. Meanwhile, we find no sufficient evidence that mutual funds dominated by open-end funds are less inclined to collude with nontradable shareholders, although an open-end fund is expected to have better governance quality than a closed-end fund due to the redemption mechanism. As for the effect of ownership structure, it is found that mutual funds with a lower institutional ownership are less inclined to collude with nontradable shareholders. Fund governance seems to deteriorate as institutional ownership increases. Providing an implication for policy making, our evidence suggests that restricting the proportion of fund shares held by institutions may help improve fund governance in China.

A fundamental question in economics and finance is whether and how removing barriers is associated with efficiency gains. We study this question using share issue privatization in China that took place through the split share structure reform as our experimental setting. Prior to the reform, domestic Ashares are divided into tradable and non-tradable shares with identical cash flow and voting rights. Under the reform, non-tradable share holders negotiate a compensation plan with tradable share holders in order to make their shares tradable. We develop a general equilibrium model to help understand the determinants of compensation and the source of gains in the process of privatization. Our key predictions are: a) there is compensation made by the non-tradable share holders to the tradable share holders if and only if the bargaining power of the former is weaker than the bargaining power of the latter; and b) the size of the compensation is decreasing in firm performance. Our second prediction contradicts conventional wisdom that fails to account for improved risk sharing after the reform. Our empirical results are broadly consistent with our model’s predictions. We conclude that better risk sharing is an important consideration in China’s share issue privatization.