China's Capital Market Revolution

A new report from Mckinsey Quarterly says:

When China first began privatizing its state-owned enterprises in the 1990s, the intent resembled that of other privatization programs around the world: to use capital market pressures to improve the performance of a large number of state-owned companies, many of which had weak balance sheets and were not as commercially focused as publicly held companies elsewhere. However, the government wanted to retain substantial shareholdings in and influence over these companies, which precluded the full privatization of state assets. To allow such companies to raise capital in that context, a two-tier ownership structure was put in place. Essentially, the original equity remained legally distinct from the new equity and formed a separate class of shares held by the existing state-linked owners. Although both classes had the same theoretical rights to profits and votes, the nontradable shares could not be sold on the public markets.

As Chinese companies have grown in scale and complexity, this system has faced several challenges. With a two-tier equity structure to manage, state-owned enterprises understandably concentrated on their most important stakeholders: the government and one or two of their largest holders of nontradable shares. Smaller holders of nontradable shares and public-market shareholders had very limited influence either on the governance of these companies or their investment decisions. This arrangement had a negative effect on the development of the Shanghai stock market. After falling from its peak in 2001, when the first wave of IPOs was complete, it progressively declined until mid-2005, losing more than half of its value. Although the two-tier share structure did not cause the slump, the uncertainties it created prevented the market from recovering over the following five years, and it also affected the overall credibility of Chinese stock markets, both as a source of capital and as a vehicle for investment.

To read more:

http://www.mckinseyquarterly.com/article_page.aspx?ar=2016&L2=5&L3=5&srid=17&gp=0