By Christopher Balding
For all their national pride and natural boosterism, Chinese officials don’t seem to think much of their own companies. Regulators have sought to limit everything from high-speed trading to short-selling, arguing Chinese firms can’t yet handle the vagaries of modern financial markets. They’re particularly leery of greater transparency, for fear of what might be exposed. Only last week, the China Banking Regulatory Commission was accused of secretly tipping off key banks to dump bonds of companies that were under investigation.
Whether such efforts are meant to protect important companies, stabilize markets or avoid national embarrassment, they're preventing China’s markets from growing up. And it’s increasingly clear that they’re unnecessary.
Anyone who questions whether Chinese companies can deal with pressure to disclose information faster and more accurately should read a new paper from Aaron Yoon, a doctoral student at Harvard Business School. Yoon looked at how firms in Shanghai responded to demands from sophisticated foreign investors for greater transparency. Many did so quite well —and they’ve been rewarded for it.
As Yoon notes, the Shanghai Stock Connect, launched in 2014 to allow international investors to trade in mainland stocks, inadvertently created an excellent natural experiment. With 568 stocks available to trade and 382 ineligible firms, the system allowed Yoon to study how companies seeking international investment performed compared to those focused solely on domestic punters.
The divergence was striking. Companies available for trading tripled “the frequency of corporate access events” and almost doubled English-language conference calls for investors. In other words, they actively increased the flow of information in hopes of courting foreign investors and securing a lower cost of capital.
Greater disclosures led to tangible gains. Companies that shared information more openly after the Shanghai trading link opened saw higher levels of foreign ownership (though still small by total stock float). When Chinese stocks peaked in June 2015 and started falling, those firms that actively communicated with investors “exhibit[ed] significantly higher foreign institutional ownership and lower return volatility.” In other words, by attracting more stable institutional holders rather than fickle Chinese investors, they were able to lower their stock price risk.
By contrast, look at the top 10 listed banks in China: They have a weighted price-to-earnings ratio of 6.8. That’s up from the past year or two, when major banks traded under 5, but it’s still effectively expecting a complete loss of equity. The market is obviously casting doubt upon the reliability of Chinese bank financial statements.
Strenuous efforts by Chinese regulators to ensure market stability are having the opposite effect. Infantilizing Chinese firms—which is effectively what they’re doing—prevents the professionalization of management and improvements in corporate governance.
By limiting information, officials only encourage investors to see red flags everywhere. The CBRC recently ordered a review of loans made to major companies, given the uncertainty around the total amount of outstanding debt owed by several firms. The order sent a range of stocks linked to major conglomerates plunging. Chinese stock regulators have on more than one occasion had to release statements or take other actions to dispel rumors that have significantly moved markets. Information quality should hardly be so poor that markets can be jolted repeatedly by whispers.
What officials seemingly fail to appreciate is that sunlight is the greatest disinfectant. If China truly wants to stabilize its markets, officials need to enforce new regulations to promote the timely, accurate and regular disclosure of information by companies to investors. Major institutions and retail investors will make better decisions, while firms that currently fudge their numbers will be encouraged to improve their corporate behavior.
Conversely, if they want to build a credible global financial market, regulators must also punish unauthorized or illegal information leaks. There is a small mountain of research suggesting that insider trading is widespread in Chinese markets. This gives rumors greater credence and makes the job of regulators that much harder.
Information is vital to global capital markets and China is no different. Its regulators should join forces with those markets rather than fighting them, and demand greater responsibility and greater transparency from China’s own companies. The best among them will be able to meet the challenge.
