An Empirical Study of Chinese Large Shareholders’ Behavior under the Background of the Split Share Structure Reform

Using the data on related-party transactions between Chinese publicly listed firms and their controlling shareholders in 2005, this article empirically examines the characteristics of related-party transactions and their impact on the firms’ performance. The results show that the companies that completed related-party transactions with their large shareholders possess a higher concentration of ownership structure and lower P/E ratios, and their performance is significantly improved after these transactions. The current related-party transaction is also not used to achieve the necessary requirements for refinancing and the tunneling behavior of large shareholders follows a significant declining trend. Further regression analysis shows that the size of related-party transactions is positively correlated with the large shareholders’ equity ratio, and is negatively related to the P/E ratio and the performance of listed companies prior to the transactions. Finally, the research reveals that Chinese listed company performance has a significant positive correlation with the size of related-party transactions and the large shareholders’ equity ratio. Since China launched the split share structure reform (SSSR) in 2005, we have attributed all the above results to the change in the environment caused by the SSSR and concluded that large shareholders prop up a listed company through related-party transactions. Notes *Zongming Tang is currently an Associate Professor at Antai College of Economics and Management at Shanghai Jiao Tong University in China. Her research areas relate to corporate governance and social network analysis. Jin Xu is an Associate Professor at Antai College of Economics and Management at Shanghai Jiao Tong University. His research areas include corporate governance and Chinese capital markets. Xiangjian Zhang is an Associate Professor at the Institute of Finance and Economics at Shanghai University of Finance and Economics. His research areas include corporate governance and investment banking. This research is supported by the National Natural Science Foundation of China (Project No. 70872073; 70702035; 71172126) and the Shanghai Social Philosophy Fund (Project No. 2008BJB017, 2010BJB010). The authors can be reached by email at [email protected]. 1. Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert Vishny, ‘Investor protection and corporate governance’, Journal of Financial Economics no. 58, (2000), pp. 3–27. 2. Stijn Claessens, Simeon Djankov, Joseph P. H. Fan and Larry H. P. Lang, ‘Disentangling the incentive and entrenchment effects of large shareholdings’, Journal of Finance no. 57, (2002), pp. 2741–2771. 3. Stephen Yan-Leung Cheung, Lihua Jing, Tong Lu, P. Raghavendra Rau and Aris Stouraitis, ‘Tunneling and propping up: an analysis of related party transactions by Chinese listed companies’, Pacific-Basin Finance Journal no. 17, (2009), pp. 372–393. 4. Eric Friedman, Simon Johnson and Todd Mitton, ‘Propping and tunneling’, Journal of Comparative Economics no. 31, (2003), pp. 732–750. 5. Winnie Qian Peng, K. C. John Wei and Zhishu Yang, ‘Tunneling or propping: evidence from related party transactions in China’, Journal of Corporate Finance no. 17, (2011), pp. 306–325. 6. Split Share Structure Reform (SSSR): in April 2005, China began full circulation reform, in which non-tradable shareholders pay compensation to tradable shareholders, realizing ‘same rights for same stock’ and ‘one stock, one price’ among all the listed companies, and after a certain period of time during which the shares are locked, the previously non-tradable shares can enter the secondary market. Therefore, the Chinese stock market entered a ‘Time of Full Circulation’. 7. Xingluan Huang and Weitao Shen, ‘Tunneling or propping: the empirical analysis on the acquisition of listed companies in China’, Economic Management no. 12, (2006), pp. 57–64; Jian Ming and T. J. Wong, ‘Propping through related party transactions’, Review of Accounting Studies no. 15, (2010), pp. 70–105. 8. The transition period of full circulation means a period from the initial time of the SSSR of the first listed company up until the locking period is over for the final listed company adopting the SSSR. 9. Yao Guangye, ‘The process, objectives and patterns of investment system reform in China’, Journal of Contemporary China 11(32), (2002), pp. 573–579. 10. Ming and Wong, ‘Propping through related party transactions’. 11. In China, there is a series of strict refinancing requirements for a listed company which is going to refinance. One of them is that the company which wants to do the season equity offering must reach the requirement that the ROE for its past continuous fiscal years is no less than 6%. 12. Xiaohong Hou, Qi Li and Wei Luo, ‘Firm profitability and embezzlement behavior of controlling shareholder’, Accounting Research no. 6, (2008), pp. 77–84, 96. 13. As well as SSSR, other reforms in China have had positive results too. For reference, please see Ling-Hin Li, ‘Economic reform in the urban land system in China’, Journal of Contemporary China 12(34), (2003), pp. 207–224

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