Download the capital structure management of chinese listed real estate

Royal Institute of Technology, Stockholm, Sweden
Department of Infrastructure
Division of Building and Real Estate Economics
Master of Science Thesis number 209
THE CAPITAL STRUCTURE MANAGEMENT OF
CHINESE LISTED REAL ESTATE COMPANIES
Supervisor:
Author:
Professor Stellan Lundström
Veronika Hui Wang
Stockholm, October 2003
1
Master of Science Thesis
Title:
The Capital Structure Management of Chinese Listed Real
Estate Companies
Author:
Veronika Hui Wang
Department:
Department of Infrastructure, Building and Real Estate
Economics
Thesis Number:
209
Supervisor:
Professor Stellan Lundström
Keywords:
Capital Structure, Corporate Bond Market, Ownership
Structure, State Owned Enterprises, Static Trade-off Model
Abstract
This thesis documents the characteristics of capital structure in 43 Chinese listed real
estate companies and investigates whether firms in the largest developing and
transition economy of the world entertain any unique features and if so, why such
feature occurred?
The research method involves a series of descriptive statistic analysis from the
Chinese listed companies´ financial and accounting database and field interviews
undertaken with companies senior financial personnel. The result shows that,
different from other countries, Chinese listed real estate companies have lower
leverage level, lower long-term debt ratio, higher equity over fixed assets ratio and
unique mixed ownership structure. The reasons for such characteristics of capital
structure in China are the undeveloped corporate bond market, the ownership
structure etc. And the result also imply that static trade-off model is more powerful
than pecking order hypothesis in explaining the features of capital structure in
Chinese listed real estate companies.
2
Acknowledgements
First of all I owe my gratitude to my supervisor, Professor Stellan Lundström, who
gave me all the support and encouragement needed to realize this thesis.
I am thankful to Associate Professor Hans Lind who offered me generous help and
valuable discussions.
Also I would like to thank my family for their understanding and mental support, as
well as for their sharing all the moments during this studying period.
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Table of Contents
CHAPTER 1 INTRODUCTION __________________________________________ 6
1.1 Background ____________________________________________________
1.1.1 History of Chinese listed companies in brief ________________________
1.1.2 Housing reform taken in China___________________________________
1.1.3 Chinese real estate market and listed real estate companies_____________
6
6
6
7
1.2
Problem Description and Aim _____________________________________ 8
1.3
Limitation and Scope of the Study__________________________________ 9
1.4
Chapter Layout _________________________________________________ 9
Chapter 2 METHODOLOGY OF THE STUDY ____________________________ 10
2.1
Two Perspectives of Science, Positivism and Hermeneutic _____________ 10
2.2
Data Collection ________________________________________________ 11
2.3
Descriptive Statistics ____________________________________________ 12
2.4
Questionnaire Structure _________________________________________ 13
2.5
Method and Resource Criticism___________________________________ 13
Chapter 3 THEORY BACKGROUND ____________________________________ 15
3.1 The Static Trade-off Model of Capital Strucutre ____________________
3.1.1 Effects of Corporate and Personal Taxes __________________________
3.1.2 Costs of Financial Distress _____________________________________
3.1.3 Static Trade-off Model of Capital Structure ________________________
3.2
15
15
18
18
The Pecking order Hypothesis Model of Capital Structure ____________ 19
3.3 Comparison of two models – Theoretical and Empirical Evidence ______
3.3.1 Theoretical comparition of two models ___________________________
3.3.2 The survey for capital structure decisions for U.S market _____________
3.3.3 Previous studies on capital structure focused on developed countries ____
21
21
22
23
Chapter 4 DESCRIPTIVE STATISTICS OF THE FEATURES OF CHINESE
LISTED REAL ESTATE COMPANIES´ CAPITAL STRUCTURES __ 24
4.1
Tend to Have Much Less Debt/liabilities____________________________ 24
4.2 Has A Mixed Ownership Structure ________________________________
4.2.1 The type of different ownership for Chinese listed companies _________
4.2.2 Mixed ownership structure in Chinese listed real estate companies______
4.2.3 Mixed ownership structure affects firm´s performance _______________
4
25
26
27
27
4.3 Long-term Debt Ratio Is Quite Low In Companies´ Balance Sheets______ 28
4.3.1 Characteristics of long-term debt in a firm´s balance sheets ___________ 28
4.3.2 Low long-term debt ratio in Chinese listed real estate companies _______ 29
4.4 Equity Over Fixed Assets Ratio Is Over 100% _______________________ 30
4.4.1 Definition of equity over fixed assets ratio and it´s application _________ 30
4.4.2 High equity over fixed assets ratio which is over 100%_______________ 30
Chapter 5 REASONS FOR CHINESE LISTED REAL ESTATE
COMPANIES´ CAPITAL STRUCTURE PERFORMANCE ________ 32
5.1
Undeveloped Corporate Bond Market In China _____________________
5.1.1 The role of a corporate bond market in an economy _________________
5.1.2 Small and quite undeveloped corporate bond market in China _________
5.1.3 Future development of corporate bond market in China ______________
5.2
32
32
33
34
Financial Manager´s Speculative Behaviour Caused Equity Financing __ 35
Chapter 6 TRADE-OFF MODEL – THE THEORY IN BETTER
EXPLANINING CAPITAL STRUCTUE IN CHINESE CASE _______ 36
6.1
Equity Financing Does Not Match The Pecking Order Hypothesis ______ 36
6.2
Ownership Structure Does Affect The Firms´ Capital Structure________ 37
Chapter 7 CONCLUSIONS _____________________________________________ 38
REFERENCES _______________________________________________________ 40
APPENDIXES ________________________________________________________ 43
Appendix 1 Interview Questions _____________________________________________ 43
Appendix 2 Introduction To China´s Securities Market __________________________ 44
5
Chapter 1 INTRODUCTION
1.1
Background
1.1.1 History of Chinese listed companies in brief
Listed companies and stock markets did not exist until the late 1980s when the
Chinese government decided to restructure the industrial sector then dominated by
state-owned enterprises (SOEs). A department store in Beijing was given permission
for issuing shares in 1984, the very first time since the founding of the People's
Republic in 1949.
A more direct cause of this bold step was the heavy losses incurred by SOEs. In the
following few years, more SOEs were "incorporated" through selling shares to their
own employees or other stock companies and SOEs. New joint stock companies were
organized in a similar way. Stock trading was prohibited and low liquidity of stocks
made it difficult for the companies to market their initial offerings. To end the chaotic
black-market trading, the State Council decided in 1989 to establish two national
stock exchanges. The Shanghai Stock Exchange (SHSE) was inaugurated in
December of 1990, and the Shenzhen Stock Exchange (SZSE) opened in April of
1991. The number of listed companies, trading volume, and total market
capitalization has increased dramatically since the opening of the two exchanges.
1.1.2 Housing reform taken in China
Until 1999, most of people in China's urban area had lived under the welfare housing
system in which the government provided nearly free housing for urban residents. All
employees from government agencies, academic and public institutions, state owned
companies, received allocated housing from the government or their work units. In
March 1998, Chinese Premier Zhu Rongji introduced a package of reforms that
included a series of housing reform - intended to stimulate the domestic economy.
He declared that subsidized housing traditionally available to Chinese workers would
be phased out and that workers would be encouraged to buy their own homes or pay
rent closer to real market prices. The reforms called for workers to use their savings,
along with the one-time housing subsidies they receive, to purchase their own
houses. The government announced in August 1999 that all vacant residential
housing units built after January 1, 1999 were to be sold and not allocated. Since
then, the private housing market has experienced tremendous growth.
Xie Jiajin, the director-general of the Department of Housing and Real Estate in the
Ministry of Construction, reported at the January 9, 2001 National Housing Reform
Conference, that over 80 percent of the allocated public housing in China have
already been sold to workers or employees. A new property ownership structure
dominated by the private ownership along with other types of ownership forms has
taken root in China.
A study completed by the Sinomonitor and the British Market Research Bureau
(BMB) indicated that from 1999 to 2000 the percentage of homeowners in China
urban areas rose nearly 10 percent, from 49.9 percent to 59 percent. There is no
doubt that the housing reform in recent years has boosted home purchase and
construction in China.
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1.1.3 Chinese real estate market and listed real estate companies
Compared with developed markets, China's real estate industry is less experienced
and immature. Currently, there are approximately 25,000 real estate brokerage
agencies employing over 200,000 agents. In addition, there are 20,000 property
management companies employing over 2 million people in China. Many of the
brokerage companies, however, may not possess business licenses and qualification
certificates. For instance, it was reported that, of the 4,000 real estate agencies
currently operating in Beijing, only about 700 have business licenses. In a recent
inspection in Shanghai, 982 real estate brokerage firms were found guilty of
operating without registration with the appropriate government agency.
During the middle and late 1990's, real estate markets in big cities in China were
overheated. Price of prime land in Beijing has fallen from the high level experienced
in the boom development period of the early 1990s. In 1999, the vacancy rate for
Grade A buildings was 30% in Beijing and 38% in Shanghai. Some experts estimated
that the vacant space might take two to three years to be absorbed if the recent
trends in demand continue. The market now seems to be picking up the momentum
when many residents are upgrading into bigger housing.
A research report by Shanghai Real Estate Economic Association for the preparation
of WTO entry cited that, in comparison with companies in developed countries,
China's local real estate companies have the following weaknesses: 1.Lack of
experiences because of short history; 2. Limited competing capability due to smaller
sizes; 3.Insufficient capital and backward marketing means; 4.Lower management
skills; 5.Not service-oriented in general.
To regulate the market and protect consumer's interest, the government released
the revised Model Commercial/Commodity Housing Purchase/Sell Contract in
September 2000. The model contract serves as a standard contract and allows
potential real property buyers and sellers to understand what are involved in a real
estate transaction. The government hopes it will eventually help consumers reduce
the risk in home purchase.
The overall real estate market in China is dynamic and grows fast in terms of capital
flow and development speed in spite of the problems. The resale housing market is
almost non-existent in China a few years ago. In 1999, the government completed
its basic policy for secondary housing market and encouraged urban residents who
owned their homes to sell smaller, older, and low-quality houses in exchange for
bigger, newer, and high-quality ones. Some cities, e.g. Shanghai and Ma Ansan of
Anhui province started experiment - the secondary market was earlier than other
cities in China. Since 1996, there have been 67,333 residential properties being put
for sales on the market in Shanghai, accounting for about 5% of the total sold
properties there in the same period. In 2000 alone, about 7.5 million square meters
(80.73 million square feet) existing houses were sold in Shanghai. The total
transaction amount was valued at RMB 65.6 billion (about U.S. $8 billion). There are
over 5,000 foreign funded real estate companies, including China-foreign joint
ventures (JVs) or cooperative enterprises, and over 1,000 wholly foreign-owned
companies currently operating in China. Hong Kong is the top investor, accounting
for over 75% of total foreign investment, followed by the United States and Taiwan.
7
69 real estate companies are listed on the Shanghai and Shenzhen stock exchanges
by the end of year 2002 (China mainland, the listed real estate companies in
Hongkong, Tai Wan and Macao are not included in this study). Among these 69 firms
there are 43 companies that focus on only property construction and development.
The 43 listed real estate companies are the main study subjects in this paper.
The top 10 listed real estate companies year 2003 are:
LuJiaZui Finance & Zone Co. Ltd. http://www.shld.com/
Wanke QiYe Co. Ltd. http://www.vanke.com.cn/
China Enterprise Co. Ltd. http://www.cecl.com.cn/
SheKou Holding Co. Ltd. http://www.cmre.com.cn/
BeiJing Construction Investment & Development Co. Ltd. http://www.bucid.com/
JiLin YaTai Group Co. Ltd. http://www.yatai.com/
China World Trade Center Co. Ltd. http://www.cwtc.com.cn
Goldfield Industries Co.Ltd. http://www.goldenfield.com/newweb/new/
ZhongYuan Development Co. Ltd.
ChangChung KaiFa Co. Ltd.
1.2
Problem Description and Aim
The institutional environment for Chinese firms has two salient features: (1) China is
in transition from a command economy to a market economy, and (2) Most Chinese
listed companies were state-owned enterprises (SOEs) before and the state still
maintains its controlling right after the firms go public. The overall real estate market
in China is dynamic and grows fast in terms of capital flow and development speed in
the past decade, and still compared with other developed markets, China's real
estate industry is less experienced and immature. So it is that Chinese listed real
estate companies entertain some unique characteristics in terms of capital structure
comparing with other firms in developed as well as many developing countries.
In this study, the aim is to answer the following three questions:
1.
2.
3.
How the Chinese listed real estate companies managing the capital structure
in terms of total liabilities ratio, long-term debt ratio, equity over fixed
assests ratio and ownership structure?
What are the reasons for such features of capital structure in Chinese listed
real estate companies?
Can we find out which model (the static trade-off model or pecking order
hypothesis) is more powerful in explaining the features of capital structure in
Chinese listed real esate companies?
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1.3
Limitation and Scope of the Study
The study is limited to Chinese listed real estate companies (the listed real estate
companies in Hongkong, Tai Wan and Macao are not included in this study) in terms
of capital structure management. A comparative study of listed companies in term of
leverage level in the G-7 countries1 and unlisted real estate companies.
The major limitation faced during the study is the language barrier. The database
which contains the market and accounting information for those 43 listed real estate
companies are in Chinese, and all the interviews are proceeded in Chinese too since
the respondents are more comfortable expressing themselves in Chinese. However,
all the market and accounting resources used are authorized as public information
database for listed companies by China Securities Regulatory Commission (CSRC)2.
And the respondents – LujiaZui Finance&Zone Co.Ltd, Wanke QiYe Co. Ltd, China
Enterprise Co. Ltd, SheKou Holding Co. Ltd, Beijing Construction Investment &
Development Co. Ltd - for the interviews are the best 5 listed real estate companies
in China. So it is assumed that the limitations have not affected the accuracy of the
study.
1.4
Chapter Layout
The rest of the thesis is organized as follows. Chapter 2 presents the methodology
that has been used in this study, which starts with a description of two perspectives
of science, followed by the data collection and the interpretative and analytical
procedure. Chapter 3 reviews the capital structure theory background in terms of
two competitive models – the static trade-off models and the pecking order
hypothesis – to make the reader get more understanding of the study. Chapter 4
discusses the result from the descriptive statistic analysis in terms of total liabilities
ratio, long-term debt ratio, equity over fixed assets ratio and ownership structure, to
document the features of capital structure in Chinese listed real seated companies.
Chapter 5 investigates the reasons for such capital structure by the results from
interviews. Chapter 6 try to find out which models (trade-off model or pecking order
hypothesis) is better in explaining the characteristics of capital structure in Chinese
listed real estate companies. Chapter 7 presents the final conclusions and
recommendations.
1
2
G-7 countries are the U.S.A, Japan, Germany, France, Italy, UK and Canada.
China Securities Regulatory Commission has homepage http://.csrc.gov.cn
9
Chapter 2 METHODOLOGY OF THE STUDY
Research methodology refers to the method and procedural framework within which
the research is conducted. It describes an approach to a problem that can be put into
practice in a research process, which could be formally defined as an operational
framework within which facts are placed so that their meaning may be seen more
clearly. It also gives methods for the researcher to answer the research problems
systematically.
In this chapter the methodology that has been used in the study is presented. This
chapter starts with a description of two perspectives of science, positivism and
hermeneutic, followed by the data collection and the interpretative and analytical
procedure.
2.1
Two Perspectives of Science, Positivism and Hermeneutic
There are two conceptual frameworks from which to approach scientific studies, the
positivistic and the hermeneutic frameworks. They have different point of views
about how to handle scientific knowledge, how to run a scientific investigation and in
which way to draw the conclusion.
The positivistic approach is the basis for quantitative, statistical methods and the roll
of the researcher is to be objective. Empirical study is very important for positivistic
approach and empirical information comes from environment reality. The ambition of
positivism is to make an objective sense of phenomenon, and explain the
environmental reality by applying reasonable logic, correct theory and relevant
information.
Compare with positivistic approach, hermeneutic approach has a more dynamic and
subjective view of science. Hermeneutic method tries to understand why things occur
in different ways, and how they are connected. Hermeneutic is a general expression
that stands for interpretation of whatever is concerned and the process of
interpretation is based on the understanding of the phenomenon. Communication is
considered extremely important in hermeneutic, because it sends the direct signal of
what have happened, which has great impact on the conclusion. Conclusions reached
by hermeneutic depend on how good the communication is, what is studied and in
which context. The hermeneutical approach provides the basis for the qualitative
studies whose main aim is to interpret and understand and in which the researcher
has to be subjective.
A distinction is usually made between quantitative and qualitative methods when we
try to reach the information we need. With quantitative studies a one-way
communication is taking place, at which the research is done at the researcher’s
conditions. In another word in quantitative research the collection of data is
expressed in statistical figures, and that is why quantitative data is often described
as “hard” data. Representative of the qualitative method can be described that the
data is “soft”, and difficult to measurable. There are three major components of
qualitative research: Data, Interpretative and analytical procedure and Report.
This study involves a review of literatures and articles on capital structure theory,
which provide a general theoretical background and is also to some extent the base
10
of the analysis. On the other hand, the study is to a great extent based on face to
face interviews, telephone interviews, e-mail interviews, observations, emphasizing
on empirical data, and drawing conclusion through the observation of the information
collected. So this study uses a combination of both the qualitative and quantitative
research methods.
2.2
Data Collection
There are two fundamental sources of data, primary and secondary data. Primary
data is material collected by the researcher himself/herself from original sources by
means of interviews, questionnaires, surveys and observations. Secondary data is
material that has already been collected such as books, articles, statistical reports
and information on the Internet.
When collecting primary data and conducting personal interviews, there are a few
aspects worthy to consider. Since interviews refer to face to face verbal exchanges,
in which one person, the interviewer, attempts to acquire information or opinions or
beliefs from another person, the interviewee, there are a lot of variables influencing
both questions and answers. And all the variables could influence on the reliability of
the primary sources. For instance, the interviews are only conducted by one person,
then the answers and the information presented are only from his/her point of view.
Or the responses to the questions are very much dependent on the personal
preferences and this may bring a narrow picture of the presented case.
As to the secondary data collection, there are both advantages and disadvantages
for it. The advantages of the secondary data are convenient and easy to reach.
Different kinds of information could be collected, and they can help the researchers
to view things from different dimensions. The disadvantages of the secondary data is
that it can be time consuming and complicated.
In this study, the data is gathered through both the primary sources and the
secondary sources.
The primary data collection consisted of interviews with financial officers or business
controllers in the top 5 listed real estate companies in China. (Four ratios were used
to measure a firm´s performance - cash flow, net operating profit, trade volume and
value of a firm. The four ratios have the same weight and score scale, the top 5
listed real estate companies are the companies with the highest scores in year
2002).
The companies were firstly contacted by phone calls to present this study and ask for
permission for interviews. Thereafter the question list (the detailed question list
structure will be introduced at next section and the list was put as appendix in this
thesis) were sent to the key persons for a review, and finally answers to the question
list were sent back by email or face to face interviews were taken to go through the
list and discuss the concerned topics. The 5 listed real estate companies are the
LuJiaZui Finance & Zone Co. Ltd (http://www.shld.com/), Wanke QiYe Co. Ltd
(http://www.vanke.com.cn/), China Enterprise Co. Ltd (http://www.cecl.com.cn/), SheKou
Holding Co. Ltd (http://www.cmre.com.cn/) and BeiJing Construction Investment &
Development Co. Ltd (http://www.bucid.com/).
11
The secondary data used have two aspects. The first aspect of the data collection
involves a literature and articles review on the subject of capital structure
management. There is plenty of material regarding Chinese listed real estate
companies (in Chinese) in libraries in China, and the Internet becomes also the main
source for this searching. The searching engines Google, EbscoHost have been used
a lot. The searching terms were capital structure, total liabilities ratio, trade-off
model, state-owned enterprises, ownership structure etc.
The second aspect of the secondary data collection is a database, which has market
and accounting data for more than 1000 Chinese listed companies up to the year
2002. The databases is http://www.cnlist.com and is authorized as public information
database for listed companies by China Securities Regulatory Commission (CSRC,
with web address www.csrc.gov.cn/CSRCSite/eng/eindex.htm). From this data base, 4 main
ratios that measure the capital structure have been selected for 43 Chinese listed
real estate companies3: total liabilities ratio, long-term debt ratio, equity over fixed
assets ratio and ownership structure.
2.3
Descriptive Statistics
A servey research tool called ”descriptive statistics” was used widely in the study,
especially on chapter 4, when discussing the features of capital structure for Chinese
listed real estate companies, all the results for the four measure ratios – total
liabilities ratio, long-term debt ratio, equity over fixed assets ratio and ownership
structure – calculated by descriptive statistics analysis.
Descriptive statistics is a branch of statistics that denotes any of the many
techniques used to summarize a set of data. In a sense, we are using the data on
members of a set to describe the set. And the descriptive statistics summary
includes the sample mean, sum of values, sum of square values, sample standard
deviation, population standard deviation, number of items in the list, minimum
value, first quartile, median, third quartile, and maximum.
Descriptive statistics fall into three main categories:
•
•
•
measures of position (or central tendency)
measures of variability
measures of skewness
Measures of position (or central tendency) describe where the data are concentrated,
which contain mean, median and mode. The Mean is simply the mathematical
average of the data. The mean provides you with a quick way of describing your
data, and is probably the most used measure of central tendency. The median is the
middle observation in a data set. And the Mode is the value around which the
greatest number of observation are concentrated, or quite simply the most common
observation.
3
There are totally 69 listed real estate companies on the Shanghai or Shenzhen stock exchanges by the end
of year 2002 (China mainland, the listed real estate companies in Hongkong, Tai Wan and Macao are not
included in this study). And in which there are 43 companies that focus on only property construction and
development. The 43 listed real estate companies are the main study subjects in this paper.
12
While measures of position describe where the data points are concentrated,
measures of variability measure the dispersion (or spread) of the data set, which
contains range, variance and standard deviation.
Measures of position and variability tell us where the data are located and how
dispersed they are. Measures of skewness are concerned with whether the data are
symmetrically distributed, or the shape of the distribution.
2.4
Questionnaire Structure
As in the “data collection” part, the data for questionnaire is the fundamental data
and collected by face to face interviews, phone interviews and e-mail interviews.
One factor that need to be pointed out before talking about the questionnaire
structure is that the interview was taken after the study of the features of capital
structure for Chinese listed companies. This means that firstly, the author for this
paper have studied the four features of capital structure (in terms of total liabilities
ratio, long-term debt ratio, equity over fixed assets ratio and ownership structure)
with the descriptive statistics analysis, and thereafter the interview was made.
So the aim for the questionnaire is to find out why such features of capital structure
for listed real estate companies occurred in China. To investigate this, the attitude
towards company funding sources and factors which might determine a company’s
overall capital structure were considered in the questionnaire and the questionnaire
has been constructed as following:
“Do tax issues have a major influence on your decisions?”
“Do you have a target debt ratio?”
“Do you have a policy of maintaining spare debt capacity?”
“Could you borrow more at the same interest rate?”
“Do you see your borrowing in industry terms?”
“Do you prefer to fund your business by means of internal or external funding
sources?”
“What is your expectation for the your company’s future corporate bond
development?”
“Do you have any preferences for short, medium, or long-term funding
sources?”
“Do you think your company’s ownership structure effect the capital
structure?” etc.
All the questionnaire and interviews are taken in Chinese, and were translated to
English later on after the survey was done. The detailed question list is put as
appendix in this paper.
2.5
Method and Resource Criticism
The method and approach needed to reach the degree of the reliability should be
independent of the researchers. The same results should have been obtained if the
13
investigation carried out by someone else using the tools that had been used by the
authors. It means the results should be stable and reliable.
A test´s ability to measure what it is intended to measure is called validity. Validity
can be classified inter three groups: Construct validity, internal validity and external
validity.
Construct validity depends on the number of sources of literature that have been
used and on the number of case studies that have been carried out. The internal
validity of a report aims to test if the empirical findings of the report justify the
theoretical parts of the report. The external validity of a report is determined by the
validity of the research tools that have been used to carry out the area of research.
This report was written by only one person. There are both advantages and
disadvantages of the author’s background. It is convinced that the author has a very
good knowledge of China, which helps to give a certain picture of this country. It is
good to let the readers to view China from a Chinese point of view. On the other
hand, the information presented and the analysis only represent the author’s
perspective. In this sense, it is very difficult to avoid the narrow personal frames of
reference.
So we can say that the construct validity of this report could be questioned. The
internal validity of the report is sufficient and high, as there is an agreement
between the empirical part and the theoretical models. The research tools such as
Internet, and published articles that are used in this report are some of the most
important and widely used by lots of researchers which means the external validity
of the report is high.
14
Chapter 3 THEORY BACKGROUND
A firm’s basic resource is the stream of cash flows produced by its assets. When the
firm is financed entirely by common stock, all those cash flows belong to the
stockholders. When it issues both debt and equity securities, it undertakes to split up
the cash flows into two streams, a relatively safe stream that goes to the
debtholders and a more risky one that goes to the stockholders. The firm’s mix of
different securities is known as its capital structure, and the choice of capital
Structure is fundamentally a marketing problem.
Brealey, Richard A, “ Principles of Corporate Finance”
Since Modigliani and Miller published their important paper4 in 1958, the issue of
capital structure has generated great interests among financial researchers (see an
excellent survey by Harris and Raviv, 1991). With respect to the theoretical studies,
there are two widely acknowledged competitive models of capital structure: the
static trade-off model and the pecking order hypothesis.
3.1
The Static Trade-off Model of Capital Strucutre
The traditional static trade-off theory emphasizes taxes and financial distress.
According to static trade-off models, the optimal capital structure does exist. A firm
is regarded as setting a target debt level and gradually moving towards it. The firm’s
optimal capital structure will involve the trade-off among the effects of tax shield and
costs of financial distress. Both tax-based and agency cost-based models belong to
the static trade-off models, such as Modigliani and Miller (1958, 1963), Miller (1977),
Kraus and Litzenberger (1973), Kim (1978), Bradley, Jarrel and Kim (1984), Jensen
and Meckling (1976), Jensen (1986), Grossman and Hart (1982), Harris and Raviv
(1990), Stulz (1990), Diamond (1989), and Chang (1999).
3.1.1 Effects of Corporate and Personal Taxes
Tax advantage of debt is the key issue when talking about effects of corporate and
personal taxes.
Firstly, we look at only the effect of corporate taxes by a simple example on table 1.
4
F. Modigliani and M. H. Miller, 1958.
15
Table 1
The tax deductibility of interest increases the total income that can be paid out to
bondholders and stockholders.
Income Statement of U
Earnings before interest and taxes
Interest paid to bondholders
Pretax income
Tax at 35%
Income Statement of L
$1,000
0
$1,000
80
1,000
350
920
322
Net income to stockholders
$650
Total income to both
$0 + 650 = $650
Bondholders and stockholders
Interest tax shield(35% x interest)
$0
$598
$80 + 598 = $678
$28
Table 1 shows simple income statements for firm U, which has no debt, and firm L,
which has borrowed $1,000 at 8 percent. Since the interest that one company pays
is a tax-deductible expense. Dividends and retained earnings are not. Thus the
return to bondholders excepts taxation at the corporate level. The tax bill of L is $28
less than that of U. this is the tax shield provided by the debt of L.
Secondly, we look at the personal taxes paid by both bondholders and stockholders.
When personal taxes are introduced, the firm’s objective is no longer to minimize the
corporate tax bill, the firm should try to minimize the present value of all taxes paid
on corporate income, “all taxes” include both corporate tax and personal taxes paid
by bondholders and stockholders.
Figure 1 illustrates how corporate and personal taxes are affected by leverage.
Depending on the firm’s capital structure, a dollar of operating income will accrue to
investors either as debt interest or equity income (dividends or capital gains).
16
Operating Income $1.00
Paid as
Interest
Paid as equity
income
Corporate tax
None
Tc
Income after corporate
tax
$1.00
$1.00 - Tc
Personal tax
Tp
Tpe(1.00 – Tc)
Income after all taxes
1.00 - Tp
1.00 – Tc – Tpe(1 – Tc) =
(1.00 – Tpe)(1.00 – Tc)
To Bondholder
To Stockholder
Figure 1
The Firm’s capital structure determines whether operating income is paid out as
interest or equity income. Interest is taxed only at the personal level. Equity income
is taxed at both the corporate and the personal levels. However, Tpe, the personal
tax rate on equity income, can be less than Tp, the personal tax rate on interest
income.
The firm’s objective should be to arrange its capital structure so as to maximize
after-tax income. We can see from Figure 1 that corporate borrowing is better if
(1 – Tp) is more than (1.00 – Tpe)(1.00 – Tc); otherwise, it is worse. The relative
tax adantage of debt over quity is
(1-Tp)
Relative tax advantage of debt =
(1-Tpe)(1-Tc)
17
3.1.2 Costs of Financial Distress
Financial distress occurs when promises to creditors are broken or honored with
difficulty, the costs of financial distress includes bankruptcy costs and Costs of
financial distress short of bankruptcy.
•
Bankruptcy costs
(a) Direct costs such as court fees.
(b) Indirect costs reflecting the difficulty of managing a company undergoing
liquidation or reorganization.
•
Costs of financial distress short of bankruptcy
(a) Conflicts of interest between bondholders and stockholders of firms in
financial distress may lead to poor operating and investment decisions.
Stockholders acting in their narrow self-interest can gain at the expense of
creditors by playing “games” which reduce the overall value of the firm.
(b) The fine print in debt contracts is designed to prevent these games. But fine
print increases the costs of writing, monitoring, and enforcing the debt
contract.
The costs of financial distress depend on the probability of distress and the
magnitude of costs encountered if distress occurs.
3.1.3 Static Trade-off Model of Capital Structure
The trade-off mode emphasized taxes and financial distress. The value of the firm is
broken down as
Value of firm
=
Value if allequity-financed
+
PV(tax shield)
+
PV(costs of
financial distress)
Figure 2 shows how the trade-off between the tax benefits and the costs of distress
determines optimal capital structure. PV(tax shield) initially increases as the firm
borrows more. At moderate debt levels the probability of financial distress is trivial,
and so PV(cost of financial distress) is small and tax advantages dominant. But at
some point the probability of financial distress increases rapidly with additional
borrowing; the costs of distress begin to take a substantial bite out of firm value.
Also, if the firm can’t be sure of profiting from the corporate tax shield, the tax
advantage of debt is likely to dwindle and eventually disappear. The theoretical
optimum is reached when the present value of tax savings due to additional
borrowing is just offset by increases in the present value of costs of distress. This is
called the trade-off theory of capital structure
18
Market Value
PV(costs of financial distress)
PV(tax shield)
Value if all-equity-financed
Figure 2
The value of the firm is equal to its value if all-equity-financed plus PV(tax shield)
minus PV(costs of financial distress). According to the trade-off theory of capital
structure, the manager should choose the debt ratio that maximizes firm value.
3.2
The Pecking order Hypothesis Model of Capital Structure
The pecking order hypothesis, first suggested by Myers and Majluf (1984), states
that there is no well-defined target debt ratio. Firms are said to prefer retained
earnings (available liquid assets) as their main source of funds from investment.
Next in order of preference is less risky debt, and last comes risky external equity
financing. It is so because the existence of the asymmetric information problem
between insider and outsider investors. Debt ratios change when there is an
imbalance of internal cash flow, net of dividends, and real investment opportunities
while the factors considered in the trade-off model are regarded as the second-order.
Many papers have extended the basic Myers-Majluf idea, such as Krasker (1986),
Brennan and Kraus (1987), Narayanan (1988), Noe (1988), Constantinides and
Grundy (1989) and Heinkel and Zechner (1990).
The pecking-order theory starts with asymmetric information – managers know more
about their companies´prospects, risks, and values than do outside investors.
Managers obviously know more than investors do. We can prove that by observing
stock price changes caused by announcements by managers. When a company
announces an increased regular dividend, stock price typically rises, because
investors interpret the increase as a sign of management’s confidence in future
earnings. In other words, the dividend increase transfers information from managers
to investors. This can happen only if managers know more in the first place.
19
Asymmetric information affects the choice between internal and external financing
and between new issues of debt and equity securities. This leads to a pecking order,
in which investment is financed first with internal funds, reinvested earnings
primarily; then by new issues of debt; and finally with new issues of equity. New
equity issues are the last resort when the company runs out of debt capacity, that is,
when the threat of costs of financial distress brings regular insomnia to existing
creditors and to the financial manager.
The pecking-order theory of corporate financing goes like this.
1. Firms prefer internal finance.
2. They adapt their target dividend payout ratios to their investment
opportunities, while trying to avoid sudden changes in dividends.
3. Sticky dividend policies, plus unpredictable fluctuations in profitability and
investment opportunities, mean that internally generated cash flow is
sometimes more than capital expenditures and other times less. If it is
more, the firm pays off debt or invests in marketable securities. If it is
less, the firm first draws down its cash balance or sells its marketable
securities.
4. If external finance is required, firms issue the safest security first. That is,
they start with debt, then possibly hybrid securities such as convertible
bonds, then perhaps equity as a last resort.
In this theory, there is no well-defined target debt-equity mix, because there are two
kinds of equity, internal and external, one at the top of the pecking order and one at
the bottom. Each firm’s observed debt ratio reflects its cumulative requirements for
external finance.
The pecking order explains why the most profitable firms generally borrow less- not
because they have low target debt ratios but because they don’t need outside
money. Less profitable firms issue debt because they do not have internal funds
sufficient for their capital investment programs and because debt financing is first on
the pecking order of external financing.
In the pecking-order theory, the attraction of interest tax shields is assumed to be a
second-order effect. Debt ratios change when there is an imbalance of internal cash
flow, net of dividends, and real investment opportunities. Highly profitable firms with
limited investment opportunities work down to low debt ratios. Firms whose
investment opportunities outrun internally generated funds are driven to borrow
more and more.
This theory explains the inverse intraindustry relationship between profitability and
financial leverage. Suppose firms generally invest to keep up with the growth of their
industries. Then rates of investment will be similar within an industry. Given sticky
dividend payouts, the least profitable firms will have less internal funds and will end
up borrowing more.
The pecking order seems to predict changes in many mature firm’s debt ratios.
These comppanies´debt ratios increase when the firms have financial deficits and
decline when they have surpluses.5 If asymmetric information makes major equity
issues or retirements rare, this behavior is nearly inevitable.
5
L. Shyam Sunder and S. C. Myers, 1999.
20
3.3
Comparison of two models – Theoretical and Empirical Evidence
It is important to test which hypothesis, trade-off or pecking order, is more powerful
in explaining firms´financing behavior. Unfortunately, there is no conclusive test.
Shyam-Sunder and Myers (1999) claim that trade-off model can be rejected and
pecking order model has much greater time-series explanatory power than trade-off
model by testing the statistical power of alternative hypotheses. However, Chirinko
and Singha (2000) show that, the pecking order is less successful in explaining
interindustry differences in debt ratios. For example, debt ratios tend to be low in
high-tech, high-growth industries, even when the need for external capital is great.
There are also mature, stable industries – electric utilities, for example – in which
ample cash flow is not used to pay down debt. High dividend payout ratios give the
cash flow back to investors instead. And the test conducted by Shyam-Sunder and
Myers (1999) generates misleading inferences and that their empirical evidence can
evaluate neither the pecking order nor static trade-off models. Fama and French
(2002) find that, pecking order and trade-off models each explains some of
companies’ financing behavior; and none of them can be rejected. Booth et al.
(2001) point out that empirically distinguishing between these two different models
has proven difficult because variables that describe one model can also be classified
as the other model variables. Partly because of this, many recent empirical studies
have employed cross-sectional tests and a variety of variables that can be justified
using any of these two models.
3.3.1 Theoretical comparition of two models
While the traditional trade-off model is useful for explaining corporate debt levels,
pecking order theory is superior for explaining capital structure changes. To discuss
both traditional trade-off model and pecking order theory is to make a better
understanding on how important financing decisions are made. In addition to the
traditional discussion of the impact of taxes, financial distress, and agency costs
upon capital structure decisions, management motivations and market perceptions
may also have great impact on these decisions. And considering both models is a
good way to appreciate the concern managers have regarding the reporting
requirements required to access capital markets and also be able to explain why
observed practice does not seem to always follow theory.
Table 2 summarizes the important differences between the two theories.
21
Table 2
Comparison of Trade-off and Pecking Order Theory Traits.
TRADE-OFF THEORY
PECKING ORDER THEORY
Conforms with value maximizing
construct
Considers managerial motivations
Assumes a relatively static capital
structure
Allows for a dynamic capital structure
Considers the influence of taxes,
transaction costs, and financial distress
Considers the influence of financial
slack and availability of positive-NPV
projects
Ignores the impact of capital market
“signals”
Acknowledges capital market “signals”
Ignores concerns regarding proprietary
data
Acknowledges proprietary data
concerns
Cannot explain many real-world
practices
Explains many real-world practices
3.3.2 The survey for capital structure decisions for U.S market
Table 3 shows the results for two separate surveys examining capital structure
decisions that revealed very similar results. In each survey financial executives were
asked which of two major criteria determined their financing decisions: 1)
maintaining a target capital structure or 2) following a hierarchy of financing.
Further, those who followed a hierarchy were asked to rank the order in which they
would use various internal and external sources of funding. The first survey (Pinegar
& Wilbricht, 1989) was of Fortune 500 firms and the second (Hittle, Haddad &
Gitman, 1992) was of the 500 largest Over-The-Counter firms.
22
Table 3
Reported Use of Financing Decision Methodologies
SURVEY
AUTHORS
RESPONDENT
GROUP
% USING TARGET
CAP STRUCTURE
% USING
HIERARCHY
Pinegar & Wilbricht
Fortune 500 Firms
31%
69%
Hittle, et al.
Large OTC Firms
11%
89%
It is easy to see from the data in Table 3 that in real-world practice financial
managers are much more likely to use a hierarchical approach than a target capital
structure rationale when making financing decisions. While this would seem to be
inconsistent with value maximization arguments, this behavior is actually very
rational given the motivations of managers and the vagaries of the U.S. capital
markets.
3.3.3 Previous studies on capital structure focused on developed countries
The majority of empirical studies of capital structure, such as Bradley, Jarrell, and
Kim (1984), Titman and Wessels (1988), Rajan and Zingales (1995), and Wald
(1999), employ data from developed countries, mainly from the US to document the
determinants of capital structure. Studies on emerging markets, such as Booth et al.
(2001) and Wiwattanakantang (2001), only appeared in recent years.
And in this study, we try to find out the features of capitals structure for Chinese
listed real estate companies and why such features occurred, and finally try to find
out which model is better in explaining the capital structure for listed real estate
companies in China.
23
Chapter 4 DESCRIPTIVE STATISTICS OF THE FEATURES OF
CHINESE LISTED REAL ESTATE COMPANIES´ CAPITAL
STRUCTURES
69 real estate companies are listed on the Shanghai and Shenzhen stock exchanges
by the end of year 2002 (China mainland, the listed real estate companies in
Hongkong, Tai Wan and Macao are not included in this study). Among these 69 firms
there are 43 companies that focus on only property construction and development.
The 43 listed real estate companies are the main study subjects in this paper.
This chapter discusses the features of these 43 listed companies´capital structures in
terms of total liabilities ratio, long-term debt ratio, equity over fixed assets ratio and
ownership structure. The main study method in this chapter is descriptive Statistics.
4.1
Chinese Listed Real Estate Companies Tend to Have Much Less
Debt/liabilities
Total liabilities ratio (TL) is defined as total liabilities divided by total liabilities plus
book value of equity and is used as the main measure of leverage in this study. The
reasons for regarding total liabilities ratio as a more appropriate measure for capital
structure are firstly, when a firm wants to obtain more debt, the creditor will
consider not only how much the firm’s long-term debt is, but also how much the
firm’s current debt and total liabilities are. So the portion of other liabilities will affect
the debt capacity of a firm; second, current debt is a quite steady part of total assets
(Gibson, 2001, p248 for US firms), and this also seems to be the case for Chinese
companies; third, many companies in China use trade credit as a means of financing,
so accounts payable should also be included in measures of leverage.
Base on the reasons stated above, the total liabilities ratio (TL) as major measure of
leverage in the analysis of the feature of Chinese listed companies capital structure.
And the measures of leverage are calculated from the year 2002 data as following
while the explanatory variables are averaged where possible to reduce the noise.
24
Table 4
Descriptive Statistics of leverage for 43 Chinese listed real estate companies
Equity Ratio
Count
Mean
Median
Standard Deviation
Minimum
Maximum
Standard Error
Sample Variance
Kurtosis
Skewness
Range
Largest(1)
Smallest(1)
Total Liabilities/debt Ratio
43
53%
54%
0.17
12%
91%
0.026422417
0.030020198
-0.099909876
-0.076165908
0.7803
0.9075
0.1272
Count
Mean
Median
Standard Deviation
Minimum
Maximum
Standard Error
Sample Variance
Kurtosis
Skewness
Range
Largest(1)
Smallest(1)
43
45%
45%
0.18
7%
87%
0.02668958
0.030630348
-0.077071177
0.056696902
0.8023
0.8728
0.0705
Note: Total Liabilities ratio and equity ratio data are averaged from year 2002
Table 4 shows that Chinese listed real estate companies tend to have much less
debt/liabilities. For example, total liabilities ratio of Chinese listed real estate
companies is 45% while the same ratios in the G-7 countries are between 54%73%6. Also Chinese listed real estate companies have lower leverage than Chinese
Unlisted real estate companies, which is 58%7.
4.2
A Typical Chinese listed Real
Ownership Structure
Estate Companies Has A
Mixed
Trade-off theory suggests that the optimal structure of leverage and ownership may
be used to minimize total agency costs8. They propose two types of conflicts of
interest: conflicts between shareholders and managers, and conflicts between
shareholders and debtholders. So it is expected that there are some correlation
between ownership structure and leverage. Here we are discussing how is the
ownership structure looks like in Chinese listed real estate companies and the effect
of such ownership structure on firm’s performance.
6
Rajan G. Raghuram, and Luigi Zingales, 1995.
This figure is from the date in China Statistical Yearbook (2002).
8
Jensen, Michael C. and William H. Meckling, 1976.
7
25
4.2.1 The type of different ownership for Chinese listed companies
Before discussing how the Chinese listed real estate companies´ownership structure
is mixed, the type of a typical Chinese listed companies´ownership is worthy to be
mentioned briefly.
Mainland China listed companies have non-public A-shares, public A-shares, B-shares
and H-shares.
•
Non-public A-shares are held by the state, founder institutions, domestic
institutions, foreign institution, and employees. The state shares are those held
by the central government, local governments, or solely-government-owned
enterprises. It is declared that the ultimate owner of state shares is the State
Council of China. State shares are not allowed for trading at Shanghai or
Shenzhen Exchange. Sometimes, a company gives a right offer and the nonpublic shareholders give up the right offer and public shareholders could buy
these shares. However, there shares are still non-public shares, which could not
be traded on the Exchanges until the China Securities Regulation Committee
(CSRC, http://www.csrc.com.cn) gives special approvals, which could take up to
several years. This is also the case for non-public A-shares held by employees.
The legal person shares are shares owned by domestic institutions. A legal
person in China is defined as a non-individual legal entity or institution. Like state
shares, legal person shares are not tradable at the two exchanges, but can be
transferred to domestic institutions upon approval from the CSRC. Sales of legal
person shares to foreign investors had been allowed until it was suspended in
May 1996.
The shares of directors and managers are tradable, but the directors and top
managers cannot trade the shares of the very companies during the time when
they are working for them. In many of the listed companies the state is the
largest or majority shareholder, while management shareholding are quite low.
•
Public A-shares are listed on the Shanghai or Shenzhen Exchange, denominated
in RMB/yuan and restricted to domestic investors. There is no restriction on the
number of shares traded, nor on holding periods. It is required, however,
tradable A-shares should account for no less than 25% of total outstanding
shares when a company makes its IPO. These shares are the only types of equity
that is traded among domestic investors at the two exchanges.
•
B-shares are also listed in mainland China, but denominated in US dollars
(Shanghai-listed companies) or Hong Kong dollars (Shenzhen-listed companies),
and were restricted to foreign investors until early 2001.
•
H-shares are listed in Hong Kong, New York, London, or Singapore and restricted
to foreign investors. Some of these firms also have B-shares, so public investors
also include B-shareholders and H-shareholders.
26
4.2.2 Mixed ownership structure in Chinese listed real estate companies
A typical listed real estate Chinese listed company has a mixed ownership structure,
with three predominant groups of shareholders - the state, legal persons
(institutions), and domestic individual investors. Many listed companies do not issue
employee and foreign shares and some other companies do offer employee and
foreign shares.
From table 5 we can see the structure of shares owned by the state, legal persons
and the sum of them in the 43 Chinese listed real estate companies as the end of the
year 2002. The calculation shows that the controlling shareholders of Chinese listed
real estate companies are often state and institutes which hold around 52% of the
stock and most shares held by controlling shareholders cannot be listed and traded
in the stock market. And only around 48% of shares of Chinese listed real estate
companies can be traded on stock exchanges.
Table 5
Descriptive Statistics of state shareholding and legal persons
(ownership structure) for 43 Chinese listed real estate companies
Count
Mean
Median
Standard
Deviation
Minimum
Maximum
Mode
Standard
Deviation
Sample Variance
Kurtosis
Skewness
Range
Largest(1)
Smallest(1)
shareholding
State
Shareholding
43
28%
23%
0.27
Legal
Persons State
plus
legal
Shareholding
persons Shareholding
43
43
24%
52%
21%
54%
0.21
0.19
0%
75%
0
0.273130397
0%
67%
0
0.212382786
0%
75%
0
0.196383204
0.074600214
-1.499021494
0.328141357
0.75
0.75
0
0.045106448
-0.932205189
0.562828765
0.6667
0.6667
0
0.038566363
0.541501009
-1.030850727
0.75
0.75
0
4.2.3 Mixed ownership structure in Chinese listed real estate companies
affects firm´s performance
One research project “ Ownership Structure, Corporate Governance, and
Firms´Performance”(PRO 681-08), funded by the World Bank’s research support
27
budget, was taken on in year 20029. One of the subjects from this research is the
case from China.
Results from this empirical analysis show that ownership structure indeed has effects
on the performance of the stock companies. Also, because the state is the controlling
shareholder for most listed companies, if it does not change its behavior towards the
firms, the firms are less likely to run into financial crisis compared with their
counterparts whose controlling shareholders are individuals or private institutes,
which are wealth-maximization oriented. Empirical evidence also points to the
inefficiencies related to the state ownership, and to the importance of relative
ownership concentration and the role of large and institutional shareholders.
First, market-oriented reform measures that China has adopted seem to have
improved the economic efficiency of the state sector. However, optimal resource
allocation is unlikely to be achieved simply by creating markets for products, workers
and managers, without changing the ownership structure of SOEs. The internal
incentive structure of SOEs must be reformed by diversifying the state ownership.
And by introducing other forms of large stakeholders including institution investors.
It would be an improvement if the government reduces or sells off the shares it holds
in the stock companies.
Second, if ownership diversification is needed, is dispersed private ownership then
the answer for large and medium sized enterprises in China? The results seem to
suggest a negative answer. Evidence show that the influence of individual
shareholders to firm’s profitability is insignificant, if not completely irrelevant. In
many cases, the coefficients for the fraction of equity held by individual investors are
significant but negative, indicating that the market values individual private
ownership downward. Apparently, these publicly-traded corporations in China
suffer from the traditional free-ride problem. Individual shareholders have no
incentive and no capability to monitor and influence the behavior of the
management. Therefore, a certain degree of ownership concentration is needed.
Third, the result found a positive correlation between ownership concentration and
firms’ performance. In particular firms’ profitability is positively and significantly
correlated with the fraction of legal person shares, suggesting that large legal person
shareholders (institutional investors) have the incentive as well as the power to
monitor and control the behavior of the management, and have played a significant
role in corporate governance. The result is robust when indicators of both
concentration and ownership mix are included in the regressions.
4.3
Long-term Debt Ratio Is Quite Low In Chinese Listed Real Estate
Companies´Balance Sheets
4.3.1 Characteristics of long-term debt in a firm´s balance sheets
"Term" refers to the time for which money (a secured loan) is required and the
period over which the loan repayment is scheduled. A long-term loan is arranged
9
This study was funded by the World Bank´s Research Support Budget under the research project
“Ownership Structure, Corporate Governance, and Firm’s Performance”(PRO 681-08). Paper is available
in http://www.worldbank.org/html/dec/Publications/Workpapers/WPS1700series/wps1794/wps1794.pdf
28
when the scheduled repayment of the loan and the estimated useful life of the assets
purchased (e.g. building, land, machinery, computers, equipment, shelving, etc.) are
expected to exceed one year. Long-term loans are normally secured, first, by the
new asset (s) purchased (up to 65%) and then by other unencumbered physical
assets of the business (for the remaining 35%), or failing that, from additional funds
from shareholders or personal guarantees from the principals. On the balance sheet,
the equipment purchased shows up in the long-term assets section, while the
counterpart loan information is shown in the current and long-term liabilities
portions. The useful life of the assets is directly reflected in their depreciation
schedules.
The providers of basic long-term loans (creditors) include the Banks, the Trust
Companies, the Insurance Companies, the Pension Funds and various Loan
Specialists.
Debt lenders (creditors) make loans to businesses that exhibit strong management
ability and steady growth potential. A written business plan, including a cash flow
demonstrating the business ability to repay the loan principal and interest over the
term of the repayment schedule, is mandatory. The lender will expect you to have
appropriate insurance to protect the assets.
The long-term debt has the following Characteristics:
• Principal repaid over a period of time directly related to the useful life of the
asset(s) (e.g. land and buildings - up to 30 years, computers - 3 years).
•
Loan carries both interest and principal repayment provisions in a set
repayment schedule. Early repayment may entail a penalty because the
lender had not planned an alternate investment for that money.
•
The percentage interest rate normally remains constant for the term of the
loan. Each payment of principal reduces the balance of principal remaining
and the subsequent interest is calculated on this reducing balance.
•
Different lenders make different types of term loans. Term loans often carry
lower interest rates than operating loans because the term is fixed and the
loans are secured by assets (asset-backed).
4.3.2 Low long-term debt ratio in Chinese listed real estate companies
From year 2000 to 2002, the average of long-term debt ratio in Chinese listed real
estate companies is 7.97%, 7.03% and 7.15%10, and this ratio level is low.
There are benefits for long-term debt financing comparing with short term debt
financing:
•
Taking out a short-term loan when a longer term loan is required can quickly
create financial problems since you may be forced to take unnecessary measures
(such as selling a piece of the business) to meet the obligation.
10
This figure comes from the balance sheets from year 2000 to year 2002 for Chinese listed real estate
companies.
29
•
In general, use short-term loans for short-term needs, it will help company to
avoid higher interest expense and more restrictive conditions of longer-term
borrowing. For instance, if a company experience a temporary rapid increase in
sales -- such as that brought on by increased seasonal demand -- then a shortterm loan should be looked at. If the growth will continue over a long time, take
a look at longer-term options such as an expanding line of credit based on sales,
accounts receivables, or inventory ratios.
By the result shows above, we can say that Chinese listed real estate companies
tend to rely on external financing, especially equity financing at the aggregate level.
And the reasons for such low leverage and long-term debt ratio will be discussed on
chapter 5.
4.4
Equity Over Fixed Assets Ratio Is Over 100% In Chinese Listed Real
Estate Companies
4.4.1 Definition of equity over fixed assets ratio and it´s application
Equity over fixed assets ratio is to measure a firms´s finance structure stability, and
it is defined as amount of equity divided by total fixed assets11.
Equity over fixed assets ratio = (total fixed assets / equity) * 100%
Equity over fixed assets ratio reflects the percentage of the equity that has been
used to purchase the fixed assets. Since the equity has no “maturity date”, it is the
good source for long-term cash financing for the firm. When the equity over fixed
assets ratio is lower than 100%, it shows that firm’s capital structure is stable, and
even when long-term debt becomes due for payment, the firm does not need to
auction off fixed assets to pay back the loan. And when the equity over fixed assets
ratio is higher than 100%, it shows that all the equity part is used on the fixed
assets investment, and the firm has to auction off fixed assets to pay back the loan
on the maturity date.
4.4.2 Chinese listed real estate companies have high equity over fixed
assets ratio which is over 100%
Figure 3 shows that the average equity over fixed assets ratio for Chinese listed real
estate companies during year 1998 to year 200212. From year 1998 to year 2002,
the average equity over fixed assets for Chinese listed real estate companies are
106.50%, 104.34%, 104.72%, 92.77% and 101.25%. This result shows that almost
all the funding resource for the fixed assets investments comes from equity. And
even during year 2001, the equity over fixed assets ratio is relatively low as 92.77%,
the sum of equity and long-term debt was still higher than fixed assets.
11
Fixed assets defined as a long-term, tangible asset held for business use and not expected to be converted
to cash in the current or upcoming fiscal year, such as manufacturing equipment, real estate, and furniture.
12
This figure is calculated from the data in China Statistical Yearbook (1998-2002).
30
Average of equity over fixed assests ratio
Average of equity over fixed assests ratio
110.00%
105.00%
100.00%
95.00%
90.00%
85.00%
1998
1999
2000
2001
2002
Figure 3
The average equity over fixed assets ratio for Chinese listed real estate companies
during year 1998 to year 2002
31
Chapter 5 REASONS FOR CHINESE LISTED REAL ESTATE
COMPANIES´ CAPITAL STRUCTURE PERFORMANCE
5.1
Undeveloped Corporate Bond Market In China
As we discussed before, Chinese listed real estate companies have much lower
leverage compared with companies in other economies and even the unlisted
companies in China. One possible reason is that the corporate bond market in China
is very small and quite undeveloped.
One of the main issues on the questionnaire is regarding the attitude to funding
sources. After the study of the features of capital structure for Chinese listed real
estate companies, the fact that the firms choose to prefer equity than debt financing
is clear. To issue corporate bond is a kind of debt financing, the corporate bond
market is so little and undeveloped in China. On the other hand there is a great
potential on corporate bond market. So the discussion about the corporate bond
market with the financial managers in the 5 real estate companies - LuJiaZui Finance
& Zone Co. Ltd (http://www.shld.com/), Wanke QiYe Co. Ltd (http://www.vanke.com.cn/),
China Enterprise Co. Ltd (http://www.cecl.com.cn/), SheKou Holding Co. Ltd
(http://www.cmre.com.cn/) and BeiJing Construction Investment & Development Co. Ltd
(http://www.bucid.com/) - was taken too.
5.1.1 The role of a corporate bond market in an economy
Corporate bonds are debt obligations, or IOUs, issued by private and public
corporations. They are typically issued in multiples of $1,000 and/or $5,000.
Companies use the funds they raise from selling bonds for a variety of purposes,
from building facilities to purchasing equipment to expanding the business.
When you buy a bond from a corporation, you are lending money to the corporation
that issued it, which promises to return your money, or principal, on a specified
maturity date. Until that time, it also pays you a stated rate of interest, usually
semiannually. The interest payments you receive from corporate bonds are taxable.
Unlike stocks, bonds do not give you an ownership interest in the issuing
corporation.
“When a well-developed corporate bond market is present, market forces have a
much greater opportunity to assert themselves, thereby reducing systemic risk and
the probability of a crisis. This is because such an environment is associated with
greater accounting transparency, a large community of financial analysts, respected
rating agencies, a wide range of corporate debt securities and derivatives demanding
sophisticated credit analysis, and efficient procedures for corporate reorganization
and liquidation. In addition, the richness of available securities will tend to economic
welfare, and the market forces at work on the wide array of bond prices are likely to
have a strong spillover effect on the health of the banking system as well”13.
13
See Nils H. Hakansson “ The role of a corporate bond market in an economy – and in avoiding crises”.
32
The only country with a well-functioning corporate bond market at this time is the
United States. As a percentage of GDP, bond market financing in other countries is a
small fraction of the U.S. number (see e.g. Rajan and Zingales 1995, Sapsford 1997,
Pomerleano 1998).
5.1.2 Small and quite undeveloped corporate bond market in China
Analysts say that China's corporate bonds are still severely undersupplied.
Outstanding corporate bonds were worth about 50 billion yuan (US$6 billion) at the
end of 2002, or less than 1 per cent of China's gross domestic product. At present,
only 11 corporate bonds are listed on China's two stock exchanges.
Certain problems with the corporate bond market in the 1980s, caused the
government to set up very tight regulations. The corporate bond market was kicked
off by enterprises in Shanghai, Shenzhen and Sichuan and Liaoning provinces, in
1984. By 1986, some Rmb 10 billion ($1.2 billion) worth of corporate bonds had
been issued - but many companies defaulted, causing investor anger and the threat
of social unrest. The market was chaotic. So in March 1987, the State Council
cracked down by limiting debt issuance to state-owned enterprises (SOEs) and
limiting coupons to a maximum 40% above the comparable bank interest rate. The
government has kept a tight hold over the market ever since.
The State Development and Planning Commission determines the kinds of companies
that can issue debt, and sets a quota each year. The People's Bank of China (PBOC),
the central bank, sets all interest rates, including the extent to which bond rates can
differ from deposit rates, while the China Securities Regulatory Commission (CSRC)
supervises the trading of bonds that actually make it to the market. Supervision by
these departments was so tough that during the mid-1990s only about Rmb15-20
billion in corporate bonds were issued, below the annual quota of around Rmb20-30
billion.
The reasons for such small and undeveloped corporate bond market in China can be
as following:
•
China's corporate law only allows State-owned enterprises (SOEs) to issue
corporate bonds, leaving private enterprises out in the cold.
•
All the corporate bond issuers are State-owned giant enterprises such as China
Mobile or massive infrastructure projects like the Three Gorges Dam.
•
Corporate bonds are subject to several regulatory authorities, making the process
complicated, opaque and time-consuming.
•
The State Development Planning Commission (SPCD) holds the approval power
for bond issuance and sets an issuance quota each year. The People's Bank of
China, the country's central bank, sets interest rates while the China Securities
Regulatory Commission, the securities market watchdog, is in charge of bond
trading in the markets.
33
•
Furthermore, as bond issuers are all large-scale State-owned enterprises, which
are, or used to be under the supervision of various ministries, they are supposed
to receive permission from the ministries before going ahead with the application.
In addition, the lack of a formal application procedure also keeps many
enterprises out of the market.
5.1.3 Future development of corporate bond market in China
During the interview about the firm’s funding sources, all the financial managers are
very interested in issuing corporate bond in the future and also have the believe that
the corporate bond market will take progress rapidly in near future.
A surge of new corporate bond issues, including several eye-catching issuers such as
China Mobile, since last year may well indicate that the industry is reviving.
Signals from high-ranking officials also show that the government is committed to
revitalizing the country's nascent corporate bond market. Various media reports say
that the SDPC has finished the decade-long revision of corporate bond regulations to
relax harsh requirements on corporate bond issuance. The draft has been submitted
to the State Council for final approval.
Zeng Peiyan, head of SDPC, told a press conference held on the sidelines of the 16th
Party Congress last November that China is currently revising the Regulations on
Management of Corporate Bonds, and three major changes are expected. Changes
are to be made to the approval system in bond issuance, allowing more market
forces into corporate bond issues and interest rates, and making clear the credit
rating differentials of corporate bonds.
Under the new rules, firms would no longer have to be profitable for three years
prior to bond issues, and issuers would be allowed to invest the proceeds in projects
other than fixed assets. With the anticipated new rules, analysts forecast more
corporate bond issuance this year. One important issue is how to conduct bankruptcy
proceedings since SOEs must currently ensure they have met all their wage and
welfare liabilities before creditors get a cent. In other jurisdictions, it is bondholders
who are protected first.
So far some 61 companies have announced their intention to issue convertibles,
raising at least RMB40 billion in total. It has been reported that 50 more have been
given the green light. The first to go since the 2001 rules were announced was
Shenzhen Wanke, which issued a RMB1.5bn convertible with a 1,5% coupon in June
2002. China's corporate bond market poised to boom, said China expert on an
interview on August 2002.14 Given the current gloomy stock market and society's
urgent need for diversified investment avenues, it is now a good time for the
corporate bond industry to pick up rapidly.
14
Article from FinanceAsia magazine, http://www.financeasia.com/Articles/924C4916-A5D3-11D681E50090277E174B.cfm.
34
5.2
Financial Manager´s Speculative Behaviour Caused The Preference Of
Equity Financing
Why do Chinese listed real estate companies have such a low long-term debt ratio?
One possible reason is that the firms prefer and have access to equity financing once
they go public as most firms enjoy a favorable high stock price. Also, the
management prefers equity financing rather tan debt financing because the equity
financing is not binding.
In China, a firm wants to be listed must get approval from several government
agencies. Government control of company listing provides some assurance against
fraud and price manipulation but it also negates the market forces. Because under
the quota system, some firms located in the remote areas got listed not because
they really wanted to be listed but because the province did not want to waste the
quota, while many firms in the coastal area really wanted to be listed but could not
get the approval due to the quota limitation.
High price volatility is a common characteristic of all emerging markets. However,
the Chinese bourses are even more volatile due to the heavy-handed government
intervention and the speculative behavior of the Chinese investors.
The Shanghai A-share Index doubled overnight from 636 on 21 May 1992 to 1341
the next day. Half a year later, it dropped 70 per cent to 370. Between July and
September 1994, the Shanghai A-share Index, again, increased more than a
hundred per cent from 400 to 1000. The high volatility of the Chinese equity markets
is consistent with the saying that there is a lack of transparency in the Chinese
equity market where information disclosure is poor and price manipulation exists.
35
Chapter 6 TRADE-OFF MODEL – THE THEORY IN BETTER
EXPLANINING CAPITAL STRUCTUE IN CHINESE CASE
In chapter 4 and chapter 5 the feature of Chinese listed real estate companies´
capital structures and the reasons for such capital structure have been discussed. We
know that Chinese listed real estate companies tend to have much lower leverage,
and a mixed ownership where the controlling shareholders often are state and
institutes, lower long-term debt ratio and high equity over fixed. And the
undeveloped corporate bond market and ownership structure lead to such capital
structure in Chinese listed real estate companies.
Although this paper is to document the features of Chinese listed real estate
companies in terms of capital structure rather than to test which model (static tradeoff model or pecking order model) are more powerful to explain such features of
capital structure, the result of the study does imply that the trade-off model is better
in explaining the Chinese listed companies capital structure.
6.1
To Take Equity Financing As Main Source Of Funds Does Not Match
The Pecking Order Hypothesis
As the result shows before, Chinese listed real estate companies tend to rely on
external financing, especially equity financing at the aggregate level comparing with
other listed companies in those developed countries and unlisted companies in
China. One possible reason is that Chinese listed real estate companies have mixed
ownership, where the controlling shareholders often are state and institutes, and
they seem to prefer equity rather than debt financing. Most shares held by
controlling shareholders could not be listed and traded in the stock markets. Because
these shareholders still can keep the controlling position after issued new equity
offerings and the offering price is much higher than book value15, the controlling
shareholders benefits from increased book value of their shares from issued equity
offerings.
In the pecking order hypothesis, firms prefer internal finance since funds can be
raised without sending adverse signals, and then if external finance is required, firms
issue debt first and equity as a last resort.
Take one example in previous studies on testing the two models – the case in the
United States. Myers and Nicholas (1984)16 pointed that, 62% of capital expenditures
came from internally generated cashflow for American companies during 1973 –
1982 and net equity issues were never more than 6% of external financing. And they
used such fact to justify the pecking order hypothesis. However, Chinese real estate
listed companies seem to be contrary to the prediction of the model.
15
16
See Huang, Samuel and Frank Song, 2002.
See Myers, Stewart C. and Nicholas S. Majluf, 1984.
36
6.2
Ownership Structure Does Affect The Firms´ Capital Structure
As we discussed in chapter 4, ownership structure does affect the firm’s performance
and capital structure is one of the performance measurements. One research project
studied by School of Economics and Finance and Center for China Financial Research
(CCFR) in the University of Hong Kong shows that firms with higher state
shareholding and lower institutional shareholding trend to have lower total liabilities
ratio and lower total debt ratio. And they also found that the companies with B- or Hshares have economically significantly higher level of leverage than those without Bor H-shares
The pecking order theory never mentioned the relationship between ownership
structure and capital structure in a firm, and the static trade-off model does predict
that ownership structure affects companies´ capital structure. So in this sense, the
trade-off model is more powerful to explaining the features of capital structure in
Chinese listed real estate companies.
37
Chapter 7 CONCLUSIONS
In this thesis the features of capital structure in Chinese listed real estate companies
are introduced in terms of total liabilities ratio, long-term debt ratio, equity over
fixed assets and ownership structure. It investigates the probable reasons for such
capital structure which focus on the reform of states-owned enterprises (SOEs) and
the corporate bond market situation in China. At last, try to find out which of the two
traditional theories – the static trade-off model or pecking order hypothesis – is more
powerful in explaining the capital structure management in Chinese listed real estate
companies.
The institutional environment for Chinese listed firms has two unique features: (1)
China is in transition from a command economy to a market economy and is the
largest developing economy of the world, and (2) Most Chinese listed companies
were state-owned enterprises (SOEs) before and the state still maintains its
controlling right after the firms go public. And considering the immature but rapidly
developed real estate market, it is not difficult to understand that Chinese listed real
estate companies have different institutional and capital structures comparing with
the firms in developed as well as many other developing countries.
Empirical evidence presented in this study shows that the Chinese listed real estate
companies have the following features in term of capital structure: (1) Chinese listed
real estate companies have less total liabilities ratio comparing to the firms in both
developed countries (e.g., US, Japan, Germany, France, Italy, UK, Canada) and
other unlisted companies in China. (2) Chinese listed real estate companies have less
long-term debt ratio with the average ratio from year 2000 to 2002 was 7.97%,
7.03% and 7.15%. (3) A typical listed real estate Chinese listed company has a
mixed ownership structure, with three predominant groups of shareholders - the
state, legal persons (institutions), and domestic individual investors. The result also
shows that the controlling shareholders of Chinese listed real estate companies are
often state and institutes which hold around 52% of the stock and most shares held
by controlling shareholders cannot be listed and trade in the stock market. And only
around 48% of shares of Chinese listed real estate companies can be traded on stock
exchanges. (4) Chinese listed real estate companies have high equity over fixed
assets ratio. During year 1998 to year 2002, the average equity over fixed assets for
Chinese listed real estate companies are 106.50%, 104.34%, 104.72%, 92.77% and
101.25%. This result shows that almost all the funding resource for the fixed assets
investments comes from equity. As to the funding source, unlike the pecking order
theory, Chinese listed real estate companies tend to rely on higher levels of external
financing, especially higher levels of equity financing.
Why do Chinese firms have such unique features of capital structure and prefer to
equity financing? In this study, two possible reasons were investigated: (1)
Corporate bond market is little and almost undeveloped in China. At the end of 2002,
Outstanding corporate bonds were worth only about 50 billion yuan (US$6 billion), or
less than 1 per cent of China's gross domestic product. At present, only 11 corporate
bonds are listed on China's two stock exchanges. In order to provide more financing
opportunities for Chinese firms, it is obviously desirable to accelerate the
development of corporate bond market in China. (2) Financial manager´s speculative
behavior caused the preference of equity financing. Once firms go public, most of
them enjoy a favorable high stock price because of high price volatility in Chinese
38
stock market. And also the management prefers equity financing rather than debt
financing because the equity financing is not binding.
In this paper the features of capital structure in Chinese listed real estate companies
and the reasons for such capital structure´s characteristics are the main issue. And
the result of the study does imply that the trade-off model is better in explaining the
Chinese listed companies´ capital structure. First, to take equity financing as main
funding source does not match pecking order hypothesis; and second the result does
find that the mixed ownership structure affects the firm’s capital structure, and this
matched the trade-off theory.
39
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42
APPENDIXES
Appendix 1 Interview Questions
Part 1 Factors that may influence a company’s capital structure
1.
Do Tax issue have a major influence on your decisions? (Yes, No, Unsure)
2.
Do you have a target debt ratio? (Yes, No, Unsure)
3.
Do you have a policy of maintaining spare debt capacity? (Yes, No, Unsure)
4.
Could you borrow more at the same interest rate? (Yes, No, Unsure)
5.
Do you make use of off-balance sheet financing techniques? (Yes, No,
Unsure)
Part 2 Attitudes to ownership structure and funding sources
1.
How your company’s structure ownership looks like?
2.
What is the reason that the state or/plus legal persons shareholding are the
controlling shareholders?
3.
Do you prefer to fund your business by means of internal or external funding
sources? (Internal, external, mix, no preference)
4.
Do you have any preference for short-, medium- or long-term funding
sources?
5.
Under what circumstances would you make an equity issue or a debt issue?
6.
Have your company considered issuing corporate bond market in the near
future? Why or why not?
43
Appendix 2 Introduction To China´s Securities Market
I.
Stock Issuance
Stock Issuance System
Currently, stock issuance is subject to approval by China Securities Regulatory
Commission (CSRC). Based on Article 11 of the Securities Law, approved by the
Standing Committee of the National People's Congress on Dec. 29, 1998, and
effective on July 1, 1999, "a public stock issuance shall follow the conditions as
stipulated in the Company Law and be submitted to the securities regulatory agency
under the State Council for verification."
Public Offering and Listing Review Committee
To ensure the fairness and quality of stock issuance examination and verification, a
Public Offering and Listing Review Committee was set up by the CSRC in 1993.
Based on Article 14 of the newly promulgated Securities Law, "the securities
supervisory agency under the State Council shall set up a Public Offering and Listing
Review Committee, examining and verifying issuance applications in accordance with
law. Comprising professionals in the agency and relevant experts specially engaged
from outside, the Committee shall cast votes over a stock issuance application and
reach a resolution on it."
Mode of Stock Issuance
Under the primary method of stock issuance, a stock's issuing price is fixed after
registration with the stock trading system, that is, the lead underwriter issues the
stock at a pre-fixed issuing price, by using the trading system of stock exchanges.
Based on Article 28 of the Securities Law, " In case premium issuance is adopted for
a stock issuance, the issuing price shall be negotiated and determined between the
issuer and the underwriter, subject to the verification of the securities regulatory
agency under the State Council."
Size of Stock Issuance
By the end of 1998, China's listed companies had issued a total of 74.61 billion
shares in the markets and had raised a total of RMB 355.31 billion. The total can be
broken down as follows: (1) A-share market: 34.302 billion shares and RMB 168.709
billion; (2) B-Share market: 9.598 billion and US$ 4.745 billion; and (3) H-share
markets: 30.719 billion shares and US$ 10.02 billion (Chart 1-1, Figure 1-1, Figure
1-2).
44
Chart 1-1 Shares offering from 1987 to 1998
Shares Issued
(100 MM)
A Share
H Share
B Share
1987 1988
1989 1990 1991 1992 1993 1994 1995 1996 1997
10
25
7
4
5
10
25
7
4
5
Capital Raised
10
(RMB 100 MM)
A Share
10
H Share
B Share
Rights Offering of
A and B Share
1998 Total
21
96
91
32
86
268
102
746
10
11
43
40
13
11
70
10
5
15
11
38
32
16
106
137
25
79
13
10
343
307
96
25
7
4
94
375 327
150
425
1,294 837
3,553
25
7
4
50
195
61
38
82
23
31
33
63
224
84
47
70
655
360
81
198
1,687
763
307
797
44
50
89
38
50
440
38
26
335
Figure 1-1 Capital Raised from A-Share Market
Figure 1-2 Structure of Shares Issued
II.
Stock Trading
China has developed a nationwide equity market with two stock exchanges located in
Shanghai and Shenzhen. The stock exchanges have been continuously updating their
technology, improving services, and consistently developing conditions that provide a
foundation to expand the market. They have also been improving trading,
settlement, and registration and custody practices, as well as, upgrading the
information transmission system.
45
Originally, China's securities market was made up of a group of independent local
exchanges. With the improvement of the securities market's regulatory system and
operational mechanisms, China's stock exchanges have developed into an integrated
marketplace with nationwide coverage.
At present, China's stock exchange trading system reaches all large and mediumsized cities with 2,412 retail branches all over the nation. More and more products
are being provided to the investors and the scale of securities trading is rising. By
the end of 1998, the total market capitalization was RMB 1,950.5 billion, equivalent
to 24.46% of GDP; the outstanding capitalization RMB 574.5 billion, 7.2% of GDP;
and the annual turnover was RMB 2,354.4 billion (Chart 2-1, Chart 2-2, Figure 2-1):
Chart 2-1 Stock Market and National Economics
(RMB 100 MM)
1992
1993
1994
1995
1996
1997
1998
GDP
Market Capitalization
Amount
over GDP
Market Capitalization of Tradable Shares
Amount
over GDP
26,638
34,634
46,759
58,478
67,885
74,772
79,748
1,048
3,531
3,691
3,474
9,842
17,529
19,506
NA
NA
965
938
2,867
5,204
5,745
3.93
10.20
7.89
5.94
14.50
23.44
24.46
NA
NA
2.06
1.60
4.22
6.96
7.20
Chart 2-2 Annual Trading of Shares all over China
Market Capt. (RMB 100 MM)
Turnover (RMB 100 MM)
Volume (100 MM)
1992
1,048
681
38
1993
3,531
3,667
234
1994
3,691
8,127
1,013
1995
3,474
4,036
705
1996
9,842
21,332
2,533
1997
17,529
30,722
2,561
1998
19,505
23,544
2,154
Figure 2-1 Annual Trading and Market Capitalization of Shares
III.
Listed Companies
No. of Listed Companies
By the end of 1998, 851 companies listed in Shanghai and Shenzhen stock
exchanges with 252.677 billion shares. This total can be broken down as follows: (1)
A-share Companies: 825; (2) B-share Companies: 106; (3) Companies issuing both
46
A shares and B shares: 80; and (4) Companies issuing both A shares and H shares:
18 (Chart 3-1, Figure 3-1).
Chart 3-1 Number of Listed Companies
Companies
Issuing A Share
Issuing B Share
Issuing A and B Share
Issuing A and H Share
1990
1991
1992
1993
1994
1995
1996
1997
1998
10
0
0
0
14
0
0
0
35
0
18
0
140
6
34
3
227
4
54
6
242
12
58
11
431
16
69
14
627
25
76
17
727
26
80
18
Total
10
14
53
183
291
323
530
745
851
Figure 3-1 Industrial Sectors
Equity Structure of the Listed Companies
Shares in China are divided in to two broad categories: untradable and tradable. By
the end of 1998, the total untradable equity of the listed companies was 166.484
billion shares, 65.89% of the total equity of the listed companies, allocated as
follows: (1) shares owned by government: 86.551 billion; (2) shares owned by legal
persons: 71.617 billion; (3) shares owned by employees and others: 8.317 billion.
Outstanding tradable shares totaled 86.193 billion shares, 34.11% of the total equity
of the listed companies, allocated as follows: (1) A shares: 60.803 billion ; (2) B
Shares: 13.395 billion; and (3) H shares: 11.995 billion (Chart 3-2, Figure 3-2).
Chart 3-2 Share Structure of Listed Companies
As of 12/31/98
No. of Shares (100MM)
Untradable Shares
Sponsor Shares
Owned by Government
Owned by Domestic Legal Persons
Owned by Foreign Legal Persons
Owned by Others
Shares Placed to Legal Persons
Shares Owned by Employees
Others
Sub Total
1,429.33
865.51
528.06
35.77
0.00
152.34
51.70
31.47
1,664.84
Tradable Shares
47
A Shares
B Shares
H Shares
Others
Sub Total
608.03
133.95
119.95
0.00
861.93
Total
2,526.77
Figure 3-2 Capital Structure
IV.
Intermediaries
Securities intermediaries include securities houses, law firms, accounting firms, asset
appraisal firms, investment advisory firms, and other entities that are engaged in
securities businesses. At present, there are 90 securities houses; 299 law firms, 103
accounting firms, and 116 asset appraisal firms engaged in securities and futures
businesses; and 100 securities and futures investment consulting institutions (97 for
securities and 3 for futures).
The CSRC, jointly with relevant authorities, has the right to grant the qualifications of
all intermediaries engaged in or related to securities activities.
V.
Investors
By the end of 1998, investors had opened 39.107 million investment accounts, of
which 155,800 were in the name of institutional investors and 38,951,200 in the
name of individual investors (Chart 5-1, Chart 5-2).
Chart 5-1Expansion of Investors
(10,000)
1992
1993
1994
1995
1996
1997
1998
Shanghai
Shenzhen
111.23
105.41
423.51
354.15
574.89
484.09
685.20
557.27
1,207.87
1,099.36
1,713.31
1,620.02
1,998.97
1,911.73
Total
216.65
777.66
1,058.98
1,242.47
2,307.23
3,333.33
3,910.70
48
Chart 5-2 Structure of Investors (1998)
(10,000)
Institution
Individual
Shanghai
6.26
1,992.71
Shenzhen
9.32
1,902.41
Total
15.58
3,895.12
Total
1,998.97
1,911.73
3,910.70
Six close-end securities investment funds were created and began operations in
1998. Each fund is capitalized with RMB 2 billion and with an investment life of 15
years.
Chart 5-3 Stocks Investment Fund
Name
Size
(RMB MM)
No. of Investors
Turnover
(RMB 10,000)
NAV
Fund Unit
Kaiyuan
Jintai
Xinghua
Anxin
Yuyang
Puhui
2,000
2,000
2,000
2,000
2,000
2,000
279,803
291,881
467,069
569,842
497,037
1,019,000
1,768,400
1,832,968
873,184
557,390
696,869
/
1.0027
1.0144
1.0598
1.0670
1.0378
/
VI.
Per
The B-Share Market and Overseas Listing
B-Share Market
In 1991, the Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange
(SZSE) began to offer B shares, providing foreign investors with a legal channel to
invest in China's equity markets.
B shares are offered and traded on these Exchanges, which designate domestic or
overseas securities dealers as specially licensed brokers to accept foreign investors'
consignment for trading. These Exchanges began to offer special seats for B-share
trading in 1994 and overseas securities dealers were allowed to engage in floor
trading via the seats.
By the end of 1998, 106 companies had issued B shares with a total of 9.589 billion
shares issued and a total of US$ 4.745 billion capital raised.
Overseas Markets
In 1993, Chinese companies began to list shares abroad. Entering the global capital
markets has been an instructive and beneficial experiment for these companies. By
the end of 1998, 43 Chinese companies had listed shares overseas, of which 31 were
in Hong Kong, 8 dual listed in Hong Kong and New York, 1 in New York, 2 dual listed
in Hong Kong and London, and 1 in Singapore. The total capital raised is US$ 10.02
billion.
49
VII.
International Cooperation
To learn from the experience of securities markets in other countries and to promote
the standardization of China's securities markets, the CSRC has paid close attention
to developing relationship with foreign securities exchanges and tried to strengthen
cooperation with securities regulators of other countries.
In 1993, the CSRC, SHSE, SZSE, the Securities and Futures Commission of Hong
Kong, and Stock Exchange of Hong Kong executed a cooperative memorandum
regarding regulatory affairs. The CSRC signed a cooperative memorandum with the
US Securities Exchange Commission in April 1994; entered into a memorandum for
regulatory cooperation with the Singapore Financial Administration in November
1995; and signed an agreement with the Ministry of Finance and Securities and
Investment Committee of the UK in October 1996. The CSRC has established
agreements for regulatory cooperation with 12 different countries and regions.
The 20th Annual Conference of the International Organization of Securities
Commissions accepted the CSRC as a formal member of the organization on July 11,
1995. The Organization selected the CSRC as a member of its executive committee
in September 1998.
VIII. Shanghai Stock Exchange
Open for business on December 19, 1990, SHSE is one of the two mainland
securities exchanges, and a non-profit membership institution and legal person. It
has been working to supply a fair, transparent and highly efficient trading
environment for market participants and ensure normal operation of the securities
market under the supervision of the CSRC.
Over the past eight years, SHSE has developed into a safe, efficient and sizable
securities market with a rich variety of choice and wide coverage. By the end of
1998, SHSE's trading floor was handling:
*438 listed companies with market capitalization of RMB1,062.6 billion, equivalent to
13.3% of GDP;
*528 listed securities with various types of securities including: equity shares (A and
B shares), securities investment funds, government bonds, corporate bonds, and
corporate convertible bonds;
*333 members;
*19.99 million investors accounts.
For over eight years, SHSE has raised a total of RMB140.814 billion for listed
companies, of which US$ 2.477 billion has been from foreign investors.
To minimize paper-based operations, SHSE uses a computerized trading system that
is based on the principle of price priority and time priority. The system automatically
matches the closest offer and bid and has a capacity of 5,000 deals per second.
Supplied with the largest satellite-based telecommunications network for securities
trading in China, SHSE utilizes trading technology that combines both tangible and
50
intangible methods, and trading information can be instantly delivered to all parties
across the country.
Shanghai Securities Central Registration & Settlement Co., a wholly owned
subsidiary of SHSE, is responsible for central registration, custody, management,
and settlement . They are capable of simultaneously completing stock transfers for A
shares and stock pre-transfer for B shares upon a deal instructed within the
computerized system. Currently, the A-share market has adopts T+1 settlement and
the B share market uses T+3.
SHSE has paid attention to create international exchanges and cooperation. During
its early days of operation, it established relationship with exchanges and
cooperation with European counterparts. SHSE signed a memorandum of
understanding with the London Stock Exchange in March 1995.
Many European securities dealers, including SBC Warburg and Barclays, are engaged
in B share transactions on SHSE. Southeast Electric Power has listed both B shares in
Shanghai and GDRs on the London Stock Exchange. In October 1998, the
memorandum of understanding with the London Stock Exchange was renewed in the
presence of Mr. Tony Blair, UK's Prime Minister . Mr. Blair even wrote an inscription
for the SHSE during the event.
IX.Shenzhen Stock Exchange
Set up on December 1, 1990 as a non-profit, self-disciplined membership institution
and legal person, SZSE has been providing a market operation environment with
appropriate facilities for concentrated and organized securities, trading and fulfill
responsibilities as stipulated in relevant state laws, regulations, rules and policies
under the supervision of the CSRC.
SZSE, guided by the principle of standardized, fair, efficient, and safe operations and
with its rapidly expanding scale, increasingly multiplying products and wider
coverage, has positively sought for growth opportunities, successfully developed into
the stage characterized by automated trading from manual matching of offers and
bids, and upgraded from a local market to a nationwide one, over the past eight
years. By the end of 1998, the SZSE's trading floor was handling:
* 413 listed companies with market capitalization of RMB 888 billion, equivalent to
11.13% of GDP;
* 483 listed securities, of which were 454 equity shares, 10 funds and 19 bonds;
* 19,117,300 investors accounts;
* 329 members; and
* Over 2,400 interconnected retail branches.
SZSE has raised a total of RMB 128 billion capital for listed companies over the past
eight years and played an important role in promoting the restructuring of stateowned enterprises and bringing forth a socialist market economic system.
51
SZSE has adopted a market trading system based on modern computerized and
telecommunications technology, fully practiced electronically automated trading.
Based on the principle of price priority and time priority, the system offers
concentrated bidding and matches offer and bid deal by deal, with a daily capacity of
10 million commissions.
SZSE has exercised a 10% price cap for both rise and fall margins within the day for
shares and funds trading to maintain market stability and stay out of daunting
fluctuations in share prices. To strengthen the front-line monitoring functions, SZSE
has developed and gradually improved an automatic real time market monitoring
system. SZSE's information system delivers market updates in a timely manner to all
domestic business points as well as over 150 countries and regions in the world via
its trading network, Internet, and Reuters terminals.
Shenzhen Securities Settlement Company, SZSE's wholly owned subsidiary, is
responsible for the registration, custody and settlement of shares listed on SZSE. An
omni-directional, tri-dimensional operation system has been set up comprised of: a
trading system, settlement system, information management system and market
monitoring system. Currently, the A-share market adopts T+1 settlement and the Bshare market uses T+3 . For years, SZSE, having been taking an open stance, has
been working to tighten the link of exchanges and cooperation with the global
securities industry and actively tap the B-share market, contributing to the steady
opening progress of China's securities markets. By the end of 1998, SZSE had 54
listed B shares with market capitalization of RMB 10.6 billion, with over 100,000 Bshare investors from 108 countries and regions.
Shenzhen Special Economic Zone Real Estate and Properties (Group) Co. issuing
ADRs in US in 1994 and Shenzhen Merchants Shekou Port Service Co. Ltd.'s
secondary listing in Singapore in 1995 symbolize SZSE's growing openness.
With China's rapid economic growth, the development of the SZSE overseas
investment market has won worldwide attention. Mr. Heath, former British Prime
Minister, Visited SZSE, and left impressed.
52