This presentation formed part of the Imperial 320 session that took place on Monday, 16 January. Title of talk: The Chinese stock market. The size of the Chinese stock market is the second largest in the world. The poor performance of this market over the period 2000-2014, relative to developed and large emerging markets as well as unlisted firms in China, has been striking. This is despite the fact that the Chinese economy, the largest in the world in PPP terms, has been the fastest growing economy globally for the past three decades. We examine reasons for the disconnection between economic growth and stock market performance. Problematic IPO and delisting processes exacerbate the adverse selection of firms into the market. With much higher levels of investment compared to listed firms from the US, Japan, India and Brazil, Chinese firms generate lower net cash flows, implying low investment efficiency. Lower cash flows are associated with more related-party transactions for Chinese firms, indicating deficiencies in corporate governance. For more information, please visit: https://wwwf.imperial.ac.uk/business-school/imperial-business-insights-320/ #Imperial320

1. The Chinese stock market
Franklin Allen
Based on joint work with Jun Qian,
Chenyu Shan and Lei Zhu
#Imperial320

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Motivation
- China’s economic growth ‘miracle’:
• GDP growth rates highest among large countries over the past 3 decades
• Size of GDP overtook that of the US in 2014 (PPP terms, IMF’s World
Economic Outlook)
• Will double the size of US around 2035 (PPP) as long as its growth rate
remains twice as high as that of the US
- Development of China’s stock market:
• Started in 1990: ‘help SOEs to privatize and raise funds’
• Stock exchanges in Shanghai, Shenzhen; plus Hong Kong
• Total market cap second largest in the world (behind US)

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Buy-and-hold Returns of Major Stock Indices
(1992-2014; inflation adjusted; cash dividends included)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
SSE China S&P500 US BSE SENSEX Inida
IBOV Brazil Nikkei Japan

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CPI in China (1992-2014)
4
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Jan,1992
Nov,1992
Sep,1993
Jul,1994
May,1995
Mar,1996
Jan,1997
Nov,1997
Sep,1998
Jul,1999
May,2000
Mar,2001
Jan,2002
Nov,2002
Sep,2003
Jul,2004
May,2005
Mar,2006
Jan,2007
Nov,2007
Sep,2008
Jul,2009
May,2010
Mar,2011
Jan,2012
Nov,2012
Sep,2013
July,2014
CPI
CPI

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GDP Growth in Large Countries
（2000-2014; inflation adjusted）
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Panel B. Real GDP in Large Countries from2000to 2014
China United States India Brazil Japan

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Buy-and-Hold Returns of Listed Stocks in Large Countries
（2000-2014; inflation adjusted; dividends included）
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Value-Weighted Buy-and-Hold Returns
China United States India Brazil Japan

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Buy-and-hold Returns of Stocks vs. Bank Deposits in China
（2000-2014；inflation adjusted）
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Demand Deposit 1-YearDeposit 5-YearDeposit Buy-and-Hold Stock Returns

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Research Question
How to explain the difference between the Chinese economy and the A-share
market?
• We focus on these factors：
 Listed firms are not representative of the economy because of
the nature of the IPO process
 Technical problems with the IPO process
 Problems with delisting
 Corporate governance issues in terms of the efficiency of
large-scale investment and tunneling?

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Level and Growth of Net Income of Chinese Firms by Sector
Net Income Growth
Year All SOE Non-SOE Listed Unlisted
Listed
SOE
Listed
Non-SOE
Unlisted
Non-SOE
2001 0.060 -0.033 0.168 -0.246 0.225 -0.208 -0.588 0.230
2002 0.217 0.095 0.335 0.182 0.229 0.134 0.998 0.317
2003 0.474 0.459 0.485 0.546 0.451 0.505 0.944 0.466
2004 0.424 0.350 0.480 0.448 0.415 0.473 0.257 0.493
2005 0.243 0.188 0.282 0.141 0.279 0.174 -0.152 0.302
2006 0.336 0.347 0.328 0.247 0.363 0.217 0.611 0.319
2007 0.408 0.292 0.486 0.349 0.426 0.295 0.843 0.472
2008 0.128 -0.138 0.282 -0.071 0.182 -0.089 0.044 0.294
2009 0.145 0.064 0.176 0.031 0.168 -0.018 0.311 0.171
2010 0.552 0.631 0.524 0.494 0.563 0.474 0.579 0.522
2011 0.150 0.078 0.176 0.095 0.159 0.061 0.229 0.174
2012 0.005 -0.080 0.035 -0.045 0.014 -0.036 -0.077 0.040
2013 0.104 0.000 0.137 0.420 0.054 0.439 0.353 0.128
2014 0.019 .-0.115 0.019. 0.038 -0.073 -0.010 0.220 0.034.
Average 0.233 0.152 0.279 0.188 0.247 0.172 0.327 0.283
Correlation 0.687*** 0.554** 0.643** 0.390 0.713*** 0.361 0.411 0.627**
P-Value 0.007 0.049 0.018 0.168 0.004 0.204 0.144 0.022

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Listed and Matching Unlisted Firms in China （ROA）
10
0
0.02
0.04
0.06
0.08
0.1
0.12
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Listed Firm Matched Non-Listed Firm

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- The evidence in the tables above suggest that the firms that are listed are not representative of
the economy as a whole
- The process for listing is different from other countries. Rather than firms with good prospects
being listed, the process has been political in nature:
• Each IPO must be approved by the CSRC
• In earlier years this took on the form of an explicit quota every year allocated to different
regions across the nation
• One of the main original purposes of the stock market was to provide funds for SOEs so firms
from mature industries with good political connections tended to be listed
- There are also technical problems with the conditions that firms must satisfy to be eligible for
an IPO such as positive earnings for three years prior to listing that lead to distorted incentives

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ROA around IPO: Listed firms
0.04
0.05
0.06
0.07
0.08
0.09
0.1
0.11
0.12
0.13
-5 -4 -3 -2 -1 0 1 2 3 4 5
China US India Brazil South Africa
12

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ROA around IPO: Listed vs. Unlisted Firms in China

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ST Firms in China and Delisted Firms in the US

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Comparison of Investment of Listed Firms:
Capital Expenditure/Assets

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Comparison of Listed Firms, Net Cash Flow/Assets
16

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Related-Party Transactions and Cash Flows of
Chinese firms
Panel A. RPT Outflow and Net Cash Flow
All SOE Non-SOE
Variable Model4 Model5 Model6
RPT Net Outflow/Assetst-1 -0.046** -0.044** -0.062
(-2.062) (-2.252) (-1.268)
Log (Total Assets) 0.000 -0.001 0.000
(-0.229) (-1.469) (0.037)
Leverage -0.065*** -0.054*** -0.078
(-4.615) (-3.650) (-1.792)
ROA 0.191*** 0.224*** 0.143*
(4.961) (4.073) (2.085)
EBIT Growth 0.010 0.011* 0.009
(1.447) (1.778) (1.030)
Sales Growth -0.004 0.000 -0.007
(-0.345) (0.074) (-0.402)
Intercept 0.038** 0.039*** -0.026
(3.242) (5.381) (-1.249)
Year Fixed Effects Yes Yes Yes
Industry Fixed Effects Yes Yes Yes
R-squared (%) 5.61 7.89 7.33
Observations 3503 2275 1228

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Concluding remarks
- Disconnection between economic growth and stock market in China
- Explaining the poor performance
• Firms that are listed are not representative of the economy as a whole
• Problems with the IPO listing process;
• Problems with the delisting process
• Corporate governance problems: either investment decisions are very bad
or there is tunneling or (probably) both
- Implications:
• IPO listing process: Lowering standards, encourage the listing of more
privately owned and growth firms, administrative process => market
process
• Delisting process: Tougher regulations on delisting
• Improve corporate governance