Experiences and Challenges in the Development of the Chinese Capital Market

Douglas Cumming, Alessandra Guariglia, Wenxuan Hou, Edward Lee, Douglas Cumming, Alessandra Guariglia, Wenxuan Hou, Edward Lee

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN: 9781137454621
• eBook ISBN: 9781137454638
• Topic: Business
• Subtopic: Business General
• Index: Business

The focus of the global economy has increasingly shifted toward China and emerging countries. However, despite their high growth prospects, emerging economies often lack the sound capital market and corporate governance systems necessary to promote the efficient allocation of financial resources to maintain the confidence of capital providers. As China becomes more prominent economically, the development of its capital market becomes an increasingly important issue.This book presents some of the latest academic research on China's capital markets, demonstrating some of the major issues currently being faced. Preeminent researchers in the field examine key topics such as the performance of commercial banks, dividends and ownership, financial constraints and firm performance, the role of political networks, stock price decomposition, stock return predictability, and the role of media coverage. In this book, the authors use the country's institutional background to offer useful insight into policy implications for the development of China as well as other emerging economies.

1

Introduction to Current Issues and Development of the Chinese Capital Market

Douglas Cumming, Alessandra Guariglia, Wenxuan Hou, and Edward Lee

The influence of the recent credit crisis and excess risk taking by banks on the well-being of the wider economy on a global scale provides a stark reminder of the importance of the capital market and corporate governance to modern capitalist economy. A well functioning capital market seeks to promote the efficient allocation of financial resources from capital providers to the funding of growth opportunities. An effective corporate governance system seeks to prevent expropriation and maintain the confidence of capital providers, in order to maintain their supply of financial resources to firms. Although the Western developed countries have well-established capital market and corporate governance systems, such countries lack the growth opportunities characterizing China and other emerging economies. As such, while Western developed economies struggle in recent years through the financial crisis and austerity, the focus of the global economy is increasingly transferred toward China and emerging countries. Nevertheless, despite their high growth prospects, emerging economies like China often lack the sound capital market and corporate governance system necessary to optimize their development and growth potential. Therefore, as China and other emerging countries increase their economic prominence, the development of their capital market and corporate governance becomes an increasingly important issue that is attracting the attention of academics, practitioners, and policy makers. Meanwhile, given the transition from a centrally planned to a market-oriented economy, the institutional background and environment of China offer especially interesting research settings to contribute to the literature and could provide useful policy implications to the development of other emerging economies. This book collects a set of interesting academic research that illustrates current issues and developments in the Chinese capital market.

In “Performance of Commercial Banks in China: Traditional and Non-traditional Business, Ownership Type, and Governance Interest Rate Policies,” Li and Wang examine the effect of financial and ownership factors on bank performance in China. The chapter provides evidence that the government’s reserve requirement ratio adjustments have positive impact on bank performance, and that the large state-owned banks do not necessarily underperform foreign banks. Dong, Cumming, Guariglia, Hou, and Lee, examine the cost efficiency of Chinese banks based on different model specifications in “Effects of Heterogeneity on Measuring Efficiency Scores: The Case of China’s Banking Sector.” It provides evidence that non-performing loans, ownership structure, and size are influential to banks’ optimal costs and ability to operate efficiently. Dedman and Jiang examine dividend payout of Chinese firms in their chapter, “Dividends in China,” which provides evidence that although Chinese firms pay a higher level of dividend than their UK and US counterparts, the Chinese market does not value dividend payout as highly as the UK and US markets. In “Ownership, Financial Constraints, and Firm Performance: Foreign Acquisitions of Chinese Firms,” Chen and Hua examine cross-border mergers and acquisitions of Chinese firms and provide evidence that state-owned enterprises enjoy more favorable treatments from the government and are less financially constraint.

In “Moral Hazard or Gaming? The Dysfunctional Responses to Political Connection,” Yan, Li, and Sun examine the effect of political connection on firm performance in China. They provide evidence that political connection has a positive impact on market-based measures of firm performance, but a negative effect on accounting-based firm performance. Duan, Li, and Hou examine the impact of anti-corruption campaigns in China in “The Value of Political Networks: Evidence from a Natural Experiment.” Their chapter provides evidence of stock value decline among politically connected firms around the announcement of anti-corruption investigations. In “The Stock Return Predictability and Stock Price Decomposition in the Chinese Equity Market,” Ma, Su, and Wohar examine stock price fluctuations in the Chinese equity market and provide evidence that price-dividend ratio predicts stock returns in China, and that the expected returns component of stock prices influences future returns. Wang, Ding, Hou, and Lee examine how media coverage affects stock returns and operating performance of Chinese cross-listed firms in “Media Coverage and Stock Returns: Evidence from Chinese Cross-listed Firms.” Their chapter provides evidence that firms with less media coverage are associated with better performance.

Hailed as one of the most significant economic achievements in the modern times, the economic success of China has lifted millions of people out of poverty. As China rises in economic prominence, the experiences and challenges it faces in capital market and corporate governance development deserves further attention and can provide useful lessons to other developing economies. Due to the unique institutional environment in China, we encourage future research on Chinese capital market issues that take into account issues relating to ownership structure, business culture, policy reforms, and regional differences. To gain further insight into China’s development, we also encourage researchers to conduct comparative research across the BRIC countries (Brazil, Russia, India, and China) and across the Greater China region (i.e., mainland China, Hong Kong, and Taiwan).

Douglas Cumming (

): Schulich School of Business, York University, 4700 Keele St., Toronto, ON, M3J 1P3, Canada. email: [email protected]; Alessandra Guariglia: Department of Economics, University of Birmingham, Edgbaston, Birmingham, B15 2TT, UK. email: [email protected]; Wenxuan Hou: University of Edinburgh Business School, 29 Buccleuch Place, Edinburgh, EH8 9JS, UK. email: [email protected] and Edward Lee: Manchester Business School, University of Manchester, Crawford House, Manchester M15 6PB, UK. email: [email protected].

2

Performance of Commercial Banks in China: Traditional and Non-traditional Business, Ownership Type, and Government Interest Rate Policies

Wei Li and Steven Shuye Wang

1 Introduction

The purpose of this study is to investigate the relationship between the performance of China’s commercial banks and their financial characteristics and ownership types, after controlling for related government policy changes and market condition.

Although China has already become the second largest economy in the world, the Chinese commercial banking industry is still under development. Before the start of the economic reform in the late 1970s, all banks were owned by the state, and their lending policies were directed by the central government. The first bunch of commercial banks, known as the “big four” state-owned specialized commercial banks (i.e., Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China), were established in the early 1980s.¹ In the mid-1980s, with the establishment of the Bank of Communications and the other eight commercial banks, the concept of a corporate commercial bank was officially introduced into the country.² And now the original big four banks together with the Bank of Communications are known as the “big five” state-owned commercial banks.

The Law of the People’s Republic of China on Commercial Banks, which was implemented in 1995 and revised in 2003, sets out the laws relating to the development of China’s commercial banks. With China gradually opening its financial markets to foreign countries, more and more foreign banks have established offices and branches in mainland China. After China’s accession to the World Trade Organization, China fully opened its banking market to foreign banks at the end of 2006. According to the China Banking Regulatory Commission (CBRC), by the end of 2013, the total assets of China’s banking institutions was RMB 151,354.7 billion. The percentage of foreign banks in the total assets of China’s banking institutions increased from RMB 416 billion in 2003 to RMB 2,562.8 billion in 2013.

Ownership has been extensively used as an important factor in explaining bank performance, although the empirical evidence is mixed. For example, while Altunbas, Evans, and Molyneux (2001) find little evidence that private-owned banks outperform state-owned banks in German, Bonin, Hasan, and Zhou (2005) suggest that in transition countries, government-owned banks are less efficient than domestic private banks, and foreign banks are more efficient than other banks. Although many studies generally believe that foreign bank presence helps to stabilize the host country’s banking system (Claessens et al., 2001), yet whether foreign banks’ entry helps to improve the performance of the host country’s banks, the answer depends on the host country’s economic development level (Lensink and Hermes, 2004). Studies on the performance of Chinese banks have been concentrated in the possible impacts of ownership and macroeconomic environment changes. For example, Lin and Zhang (2009) suggest that the big four state-owned banks in China are less profitable than other commercial banks over the period of 1997 and 2004. Berger et al. (2009) find that the big four banks are by far the least efficient, while foreign banks are the most efficient for the sample period of 1994–2003. Yin, Yang, and Mehran (2013) suggest that although there has been an upward trend of bank efficiency after China’s entry to WTO in 2001, the majority of state-owned banks are still least efficient. On the other hand, Li and Wang (2010) find the performance of big four banks is not inferior to other types of commercial banks, including foreign banks.

Although ownership may play an important role, the financial fundamentals of banks are obviously the most important factors in determining bank performance. However, many previous studies either ignore the role of financial factors in explaining the profitability of commercial banks in China or separately investigate the impact of bank ownership and financial characteristics on bank performance. In this study, we simultaneously examine the different roles of several popular financial factors that relate to both the traditional and non-traditional business on bank profitability and risks, in addition to owner type and government policies.

Commercial banks’ incomes can be classified into two major categories: traditional business and non-traditional business. Traditional business, the borrowing and lending of money, generates profits from the difference between interest charged and interest paid, i.e., the net interest margin (Gorton and Rosen, 1995). Non-traditional business includes all other fee-generating activities of banks, such as insurance services, investment fund operations, private wealth management, and investment banking services (Rogers and Sinkey, 1999). In discussing the performance of US commercial banks, DeYoung and Rice (2004a) find that “To be sure, the interest margin banks earn by intermediating between depositors and borrowers continues to be the primary source of profits for most US banking companies. But banks also earn substantial amounts of non-interest income by charging their customers fees in exchange for a variety of financial services.” As in the US and most other countries in the world, we confirm in this study that Chinese commercial banks still cannot change their plight of depending on traditional activities.

Our interest in this topic is further piqued by the recent controversy over the diversification of bank services in the US and other developed markets, especially after the recent financial crisis (e.g., Demirgüç-Kunt and Huizinga, 2010). Although non-traditional activities have become important sources of commercial banks’ profitability in developed markets, so far, little is known about the non-traditional activities of Chinese commercial banks until recent years (Dai and Wang, 2009; Firth, Li, and Wang, 2014). Prior studies based on developed markets data present mixed findings on whether NTR is related to a bank’s overall profitability. For US banks, Stiroh (2004a, 2004b) finds that an increased focus on non-traditional activities is associated with declines in risk-adjusted bank performance and higher risk. In contrast, Staikouras et al. (2003) find that non-interest income can stabilize profits for European banks. They believe that differences in structural and regulatory aspects lead to the inconsistent findings between European and US banks. Using a smaller sample for an earlier sample period for commercial banks in China, Firth, Li, and Wang (2014) find no empirical evidence that non-traditional activities has led to either improvement in bank performance or destabilization in banks’ returns. The Chinese banking system has been changing dramatically, especially after China’s accession of the WTO. Whether non-traditional business contri...

Table of contents

• Cover
• Title
• 1  Introduction to Current Issues and Development of the Chinese Capital Market
• 2  Performance of Commercial Banks in China: Traditional and Non-traditional Business, Ownership Type, and Government Interest Rate Policies
• 3  Effects of Heterogeneity on Measuring Efficiency Scores: The Case of Chinas Banking Sector
• 4  Dividends in China
• 5  Ownership, Financial Constraints and Firm Performance: Foreign Acquisitions of Chinese Firms
• 6  The Dysfunctional Response to Political Connections
• 7  The Value of Political Networks: Evidence from a Natural Experiment
• 8  The Stock Return Predictability and Stock Price Decomposition in the Chinese Equity Market
• 9  Media Coverage and Stock Returns: Evidence from Chinese Cross-Listed Firms
• Index