In recent months, the Chinese government has made several announcements about its state share sale plan. On November 1, the State Council, issued a policy  of improving listed companies’ quality. On November 10, five government entities, including the Securities Regulatory Commission (SRC), held a seminar about the overhaul, demanding that both central and local governments speed up their reform plans. On December 22, Li Rongrong, chairman of the state-owned Assets Supervision and Administration Commission (SASAC), said publicly that his agency will not back off from actively pushing for the nontradable share reform program. He also plans to complete the state share sale by February.


The Chinese government is in a tug of war with regular investors about the share reform. It remains unclear when the two sides will settle their differences. The government believes the reform is conducive to developing a healthy Chinese stock market. It will bring the country’s market in line with global standards, make its equity fully tradable, encourage better corporate governance and lessen government control. It also allows the state to concentrate on being a market watchdog and forgo its traditional double role as both a player and a referee in the market.

Investors, on the other hand, care about the impact such a reform will have on short-term stock prices. The long-term development of the stock market isn’t a priority to them. Further complicating the issue is the makeup of Chinese stock market investors. In addition to institutional investors, there are tens of millions of mom and pop investors who used their entire life savings to participate in the equity market. China’s brokerages and securities market are not effectively regulated, and credit institutions and rating agencies have yet to be fully set up. Therefore it makes sense that many state-owned enterprises are offering bonus shares or other compensation to tradable shareholders to win their approval of the reform and to offset any loss they may incur as more shares enter the market.


Several experts differ about the need to compensate tradable shareholders. Hunan Business College Professor Xie Maoshi said there is no reason why nontradable shareholders should pay tradable investors. The government is making this compromise just to ease its reform process. He believes the compensation plan has been manipulated by several interest groups that are the majority owners of tradable stock. The state enterprises end up overcompensating tradable shareholders, leaving state assets prey to certain groups. For example, if tradable shareholders receive three bonus shares for every 10 shares they own, the share reform will lead to a loss in national assets of more than 500 billion yuan, he said.


Other experts disagree. In an interview with the Shen Zhen Economy Daily, economist, dean of Yanjing Overseas Chinese University Hua Shen said it is nonsense to say that tradable investors are overcompensated. Whether a company gives too many bonus shares to its tradable shareholders will be reflected in the rise and fall of stock price. If there’s a huge jump in G shares, or shares of companies that have won shareholder support for their reform plans, it’s possible that overcompensation might have come into play. However, how can one conclude that tradable shareholders are overcompensated when nontradable shares can’t even be traded because they remain locked up for a certain period after conversion? In an interview with the same Shen Zhen paper, securities analyst Zhang Weixin said the government isn’t losing more than 500 billion yuan in assets. Instead, the state is a winner. The government’s approximately 600 billion yuan in capital in the stock market is now worth three trillion yuan in market value, Zhang said.


Online commentator Shui Pi compared the stock market reform to the controversial social-economic reforms led by Wang An Shi, a statesman and economist from the Song Dynasty in the 11th Century. Wang implemented reforms similar to the modern ideas of a planned economy and welfare state as he sought to combat issues ranging from budget deficits to inflationary pressures. While the two reforms differ in their historical periods, target groups and reform measures, they share similar goals. Both allow governments to raise funds and build a solid foundation for the development of a prosperous and stable society. Both also encounter similar obstacles in that they have been accused of sacrificing the interests of common people.


A Tug of War


To smooth the reform progress, the Chinese government has made several policy announcements. Chief among them was the early November State Council policy statement about raising company standards. The mandate, divided into six parts, emphasizes shareholder rights and corporate governance. It seeks to better monitor and regulate public companies, strengthen corporate management and ensure accountability.


That statement followed an earlier announcement by the State Council that talked about revamping and opening up China’s capital market. Premier Wen Jiabao said then that healthy public companies are critical to the success of the country’s stock market.


Shang Fulin, chairman of the Securities Regulatory Commission, echoed Wen’s view. Listed companies are the bedrock of a capital market and it’s imperative they are held to higher standards, Shang said in November.


As of December 5, 310 companies have completed or initiated their share reform plans, said SASAC chairman Li Rongrong in a December 22 meeting. The state owns, or has controlling stakes in, 175 of them. Overall, the reform program has moved smoothly, he added, and his commission remains fully committed to actively seeing it through. Some companies that have had trouble winning shareholder support may have to come up with alternative and innovative measures, he noted.


Still, the market remains unmoved, forcing some companies desperate to complete their share revisions to sweeten bonus offers for tradable shareholders. According to the Oriental Morning Post, Tsinghua Tongfang, the first company whose share overhaul plan was rejected by investors, said it would increase its offer for tradable shareholders to 3.8 bonus shares, from a previous offer of 3.66 shares, for every 10 shares they own. As a result, the total number of shares that nontradable shareholders pay to tradable investors will increase to 104 million from 99.93 million. Fang Ming, a researcher of China securities market research center, applauded Tsinghua’s revised offer, which he said was 20% higher than the average compensation offer that had been proposed.


Possible Solutions


The face-off between the government and the market is at a critical juncture. The government’s staunch position on the reform may eventually change the market’s perception and win its support. The chance looks bigger now. Huasheng, in an interview with “Beijing Mordern Business Review” on Jan. 17th 2006, said, “the reform is very successful so far.” However, that also depends on how much investors are compensated and on how much stock price may decline as a result of share dilution. Investors will abandon the market en masse, compromising companies’ abilities to raise capital, if their interests are not upheld.


Small investors cannot become the victim of China’s share reform, said Larry Lang, a professor at Cheung Kong Graduate School of Business, in a December 27 speech in Chengdu city, Sichuan province. As the largest shareholder of nontradable stock, the government has the responsibility to watch out for the interests of mom and pop investors, he said, adding that China may want to learn from British share reform and take a gradual three-pronged approach.


First, provided that the state’s stock market ownership stake remains the same, the government should hire professional managers to run and oversee businesses. Second, share reforms should be initiated for those state-owned enterprises that are well managed. “How can those companies saddled with losses be part of the reform?” he asked. Third, the government should keep control of blue-chip stocks after the reform and hold veto power over decisions that may hurt the interests of small investors.


“The nontradable share reform isn’t the magic wand that will revamp China’s stock market,’ Lang said. “The management will lose its credibility if its shares become worthless, even after shareholders are compensated.’