The impact of non-tradable share reform on the linkage between direct and indirect real estate in China

Abstract

The existence of non-tradable shares (NTSs) was a unique phenomenon in China mainland stock market. Before the non-tradable share reform (“NTS Reform”), only newly issued A-shares were tradable in the stock exchanges in China. Other shares issued before IPO (Initial Public Offerings) were non-tradable. Non-tradable shareholders are usually major shareholders who also appoint the managers (CEO) of the company. Due to the absence of the rights to transfer in the stock market, NTSs are, in theory, less valuable than tradable shares (TSs). The NTS Reform has increased major shareholders’ rights, which also increases their incentives to monitor the performance of the management and thus improves corporate governance of the company. This study aims to investigate whether the NTS Reform has impacted on the corporate governance of listed real estate companies (“Indirect Real Estate”). Previous studies are inconclusive, and the empirical results are also mixed. This study measures the quality of corporate governance by the linkage between the share price movements of the listed property companies and the price movements of the tangible asset (“Direct Real Estate”) held by these companies (“Linkage”). This measure is viable for real estate companies due to the availability of real estate price indices. Since the major form of tangible assets held by listed property companies are real estate assets, good governance should minimize the agency problems between the owners and management so that the company’s valuation reflects closely the price movements of the real estate assets it holds and therefore a stronger Linkage. This study uses the Linkage instead of other measures due to the disadvantages of other measures with respect to the difficulty in disentangling the agency effect and other factors affecting these measures. A difference-in-differences approach is used to test the impact of the NTS Reform on the changes in strength of the Linkage. The empirical results show that the increase in the strength of the Linkage after the reform for central SoEs (state-owned enterprises) is the largest and most significant, while that for private companies is the smallest. However, the difference between private and local SoEs is insignificant, which suggests that competition amongst local governments has effectively minimized the agency problem between local government and local citizens (de jure owners of the SoE), which implies that local government behaved like private individuals before and after the NTS reform. Compared with local SoEs, Central SoEs have significantly larger increase in the Linkage after the NTS Reform due to (1) a more serious agency problem between the major shareholder of NTS and the citizens of the entire country and (2) the NTS Reform provides information and incentives for aligning the interest of the central government as shareholder and citizens of China. The results are consistent with the hypotheses developed from the theoretical framework of a two-layer agency relationship for SoEs. Such theoretical framework is applicable to all companies with the government or its agency as a major shareholder and therefore should have wider implications beyond the scope of studies in this thesis.