The China Series - Part 3 : Performance and Efficiency
November 28th 2006 08:56
An Overview of China's Stock Market
Part 3 - Performance and Efficiency
Part 3 - Performance and Efficiency
Introduction
Part 1
Part 2
The split share structure reforms launched by the CSRC was predicted to cause the market to fall drastically as the non-tradable shares would be allowed to float freely depressing the market value as a result. (Gu, 2005) The anticipated outcome would probably be another blip in the Chinese stock market time series as over the years the performance of the stock market is at best been a wild roller-coaster ride. Revisiting the aim of the Chinese stock market which was to facilitate the improvement process of the restructured SOEs, with separation of ownership and management, and help to raise capital as well, has not yet been proven a success. In fact various studies have shown otherwise. Performance in terms of profitability, efficiency and sales has been proven to deteriorate after listing. (Chen et al. 2002) Even listings in overseas bourses, a privilege enjoy by the premier SOEs have failed to impact positively on performance (Huang and Song, 2002) The objective of setting up the stock market is clearly a defeated cause and in fact evolved into a casino of sorts.
Further intensive research into the efficiency of the Chinese stock market in terms of efficient market hypothesis (EMH) produced outcomes, just like the current state of its market, ambiguous with no clear distinction where the market performance, in terms of efficiency, lays.
The EMH implies that generally it is not possible to outperform the market as the prices of the securities reflect all the relevant information out there with the exception of luck or insider information being used to obtain abnormal or excess profits. This is known as informational efficiency. EMH can be classified into weak-form, semi-strong and strong. Weak-form EMH implies that prices reflect all historical returns data, semi-strong EMH reflects all publicly known information and lastly, the strong-form EMH suggest that prices reflect all public and private information and therefore excess returns can not be earned. Before answering the question of where does the Chinese stock market belongs in terms of market efficiency, first the answer must be sought for what role does market efficiency plays for the overall economy?
According to Shiguang Ma (2004), who did a comprehensive research on the Chinese stock market efficiency, “…it has been frequently documented in the financial literature that an inefficient market cannot benefit the economy as much as an efficient market. Therefore, market efficiency is the centerpiece of financial studies.”
The research by Ma concluded that the China’s stocks prices reflect information inefficiently. It is possible to obtain abnormally high returns by using historical and public information. As such, China’s stock market is neither weak-form nor semi-strong form efficient. The cause for the inefficiency is market segmentation due to inaccessibility. The split shares structure is another reason as shares segmented by trading abilities inevitably distorts the transmission and interpretation of information. Lastly, government intervention is seen as another cause as intervention leads to distortion of prices which ultimately influence the efficient allocation of resources.
From casual observation or at the ground level, the distortion of the market can be clearly seen by the actions of individual investors. Individual investors are observed to speculate shares based on rumors and not record fundamentals, a practice widely known as “stir-frying stocks”. As such, China’s stock market is generally seen as being dominated by small time and short term individual “speculators” instead of being investors. However such view needs further scrutiny as it was found out that many of the so-called individual accounts were in fact proxies for wealthy individuals and institutional investors to manipulate share prices through a complex scheme (Green, 2003) Therefore, individuals are not the main culprit for high volatility of stock prices or high turnover rates, as often assumed.
Due to existent of three different types of shares in a listed company, there are different pricing for each type and it is important to note that fair valuation should only be based on IPs or market-tradable shares and exclude restricted shares, as the remaining two-third restricted shares cannot be ascribed at market price. On the other hand, LPs are being traded regularly OTC, and are often sold to private enterprises or individuals, which bring about a new situation that the listed SOEs are not one-third but two-third privatized. (Green and Black, 2003)
Having covered China’s stock market in terms of empirical studies and ground level observation, both concluded that the market is indeed inefficient due to various reasons such as company valuation can only be done for one-third of its capitalization, massive speculation, price manipulation and government intervention.
A Chinese retail investor/speculator
Coming Up Next: Part 4 - What is in for the future and conclusion.
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