Corporate Governance And The Expiration Of Restricted Share Lockups: Evidence From The Nontradable Shares Reform In China

Since Shanghai Stock Exchange(SSE) and Shenzhen Stock exchange(SZSE) were founded and in operaions in 1990 and 1991, shares in the Chinese stock market were split into tradable shares and nontradable shares.Nontradable shares were held by the controlling shareholders who were mainly the state or state owned companies and were prohibited from trading in the second market, only were transferable to domestic institutions via private negotiation upon approval from the China Securities Regulatory Commission. This regulation was designed to ensure the absolute control of these shares by the government but also created the conflicts between controlling shareholders and minority shareholders. So China launched the Split-share reform in 2005, each firm had experience the reform period, which transferred the non-tradable shares to restricted shares, and the restricted period, after which the retricted shares can be traded on the second market. In this period, Chinese stock market had experienced the alternation of bull and bear market. My research focuses on the problems emerging from different stages in this reform, more specifically, the agency problem in the reform stage and the market efficiency problem in the lockup expiration of restricted shares.The split structure in the Chinese stock market causes a special case of separation of control rights from cash flow rights, thus controlling shareholders only undertake a minority proportion of negative corporate consequences. While controlling shareholders don’t have trading rights before nontradable shares reform, they may engage in expropriating activities that would compensate for the lack of trading rights such as cash dividends but don’t care too much about stock volatility as long as idiosyncratic risks are controlled within safe range. So in the first part, my research investigates the agency costs before and after the reform to provide evidence of improvement of corporate governance and the effectiveness of the reform.My study provides different proxies to evaluate not only managerial agency costs but also controlling shareholders’ agency costs. I use expense ratio and discretion ratio to measure managerial agency costs. As I have distinguished different incentives for controlling shareholders’expropriating of minority shareholders, I choose other receivables and related party transactions deflated by total assets as proxies for agency costs caused by the divergence of interests between controlling and minority shareholders, and dividends as indicators for agency costs caused by NTS holders’ compensation motivation. Last I use efficiency ratio, manipulation ratio and diversification indicator to stand for agency costs may be caused by both conflicts between managers, controlling shareholders and minority shareholders.Different from previous studies, my study analyzes different motivations that generate tunneling. Although a firm that is fully-owner-managed is impossible be found in publicly listed firms, thus it is difficult to find a zero-agency-cost base case according to Jensen and Meckling’s definition. My paper considers firms after the nontradable shares reform as zero-compensation-agency-cost firms, thus by comparing agency costs before and after the reform, I am able to provide relative agency costs and distinguish agency costs caused by the compensation motivation of NTS holders for the lack of trading rights from the traditional agency costs caused by the conflicts of interest of between controlling and minority shareholders. I also use compensation to TS holders during the reform as instrumental variables as it is not related to the post-reform agency costs. My findings show the scope of agency problems, test the value of trading rights and provide evidence that supports for the changes in corporate governance of companies after this financial reform, and also contribute to the privatization literatures.After the completation of the reform, in order to prevent the controlling shareholders to sell their stocks immediately and to alleviate the pressure of the large amount of shares released to the second market, the China Securities Regulatory Commission implemented the Measures for the Administration of the Share-trding reform of listed companies. In the second part of the paper, my research investigates a sample of 747 Chinese listed companies which experienced the first lockup expiration. Using the standard event study method, I find a significant negative average abnormal return three days before the lockup expiration day, and a positive abnormal return on that day. About twenty-three days after the reform, the average cumulative abnormal return experiences a slight reversal but still remains to be negative, which provides support for the price pressure hypothesis and downward-sloping demand curve hypothesis. Significant positive abnormal turnover has shown up twelve days before the lockup expiration day, but turns to be negative on and after that day.As the inability to sell owned shares is deemed the most stringent short-sale constraints, the study on lockup expiration provides a natural experiment on the role of heterogenous beliefs and short-sale constranits on the overpricing of Chinese A stocks. The third part of my paper investigates the characteristics of Chinese investors, which contributes to the literature on the overpricing of Chinese A-stock market from the view of behavior finance. My paper proposes five hypotheses in a subsequent logic, first, on a basis of jointly effects of short-sale constraints and heterogenous beliefs in the Chinese A stock market, high idiosyncratic stocks portfolio has lower future return. Second, turnover and stock float is significantly negative related, which provides that high turnover in Chinese A stock market is lightened mainly by speculation motivation. Third, higher of the idiosyncratic volatility, stock price and turnover is higher. Fourth, stock price tends to go down after the lockup expiration, the extent to which is highly positive related to the idiosyncratic volatility before the lockup expiration day. Last but not the least, on one hand, if demand curve of the stock is downward-sloping and there is a large amount of insider trading around the expiration day, then higher abnormal turnover would be observed within higher idiosyncratic volatility portfolios. On the other hand, given Chinese A stock market is driven by speculation motivation, the relation between ex-ante idiosyncratic volatility and ex-post abnormal turnover would be just the opposite. My research also provides cross-sectional test in the subsequent part.