Trading constraints with unspecified constraint horizon are imposed on the shares held by the state in the IPO of each listed firm in China Stock Market. In 2005, a so-called Split Share Structure Reform (also known as Division Reform) was launched in which the holders of restricted shares give up a proportion of their shares to purchase the right to terminate the trading constraint. From the size of the compensation, we infer the value of restricted shares and find that their price discounts are negatively affected by the restriction looseness captured by our proposed new multi-dimensional measure and positively affected by the bargaining power of the holders of freely-traded shares.

Imposed trading constraints act as an exogenous source of illiquidity, prevent free trading of restricted shares and make them be priced at a discount relative to their freely-traded counterparts with identical dividends and voting rights from the same listed firms. This paper numerically solves the theoretical illiquidity discounts for the case of long constraint horizons and then reconciles the contradictions in the results of various frameworks by identifying the effects of the unlimited and costless borrowings assumed in Longstaff (2001). With control of leveraged positions, illiquidity discounts increase with the volatility, and their size is greatly diminished. We also empirically test the theories within the unique setting of China, which has virtually the largest population of restricted shares worldwide. Large discounts are documented in two forms of transactions in restricted shares: namely auctions and transfers. The results empirically verify the theoretical findings by showing that illiquidity discounts in auctions increase with both the volatility and constraint horizons. The results from transfers, however, are not significant as the transfers are made privately and may be subject to price manipulation when the involved parties are related.

We investigate considerations (compensations) paid in on-going Division Reform, a process of releasing trading constraint, in China Stock Market, and link this event with existing literature of restricted asset by inferring implied illiquidity discount of restricted shares from consideration. We also propose a new measure of restriction capturing multiple dimensions of restriction finding it together with the scale of restriction well explain the ratio of considerations and the implied illiquidity discount. We also use theoretical models to justify the 20% implied illiquidity discount and find it is below the 48.67% upper bound suggested by Longstaff (1995) and it falls within the range between 12.18% and 23.82% suggested by Lonstaff (2001) concluding the considerations paid in Division Reform is adequate and relative wealth of two classes of shareholders remains after the trading constraint released.