Dissecting the Long-term Performance of the Chinese Stock Market

Abstract

The Chinese economy, the largest in the world in PPP terms, has been the fastest growing for the past forty years among large economies. The Chinese stock market, established in 1990, is the second largest in the world in terms of market capitalization. Stock market returns have been unrelated to future growth rates of the economy. During the period 2000-2017, stock returns of domestically listed Chinese firms are lower than that of listed firms from large developed and emerging countries, as well as externally listed Chinese firms. The performance gap, as measured by net cash flows, between domestically listed firms and externally listed and matched unlisted Chinese firms, is greater than the gap between the state-owned and privately-owned Chinese firms. We argue that differences in institutional features can explain this performance disparity of the Chinese domestic market. Problematic IPO and delisting processes lead to adverse selection of firms entering and staying in the market. With higher levels of investment compared to listed firms from the US, Japan, India, Brazil and externally listed firms, China’s domestically listed firms generate lower net cash flows, implying low investment efficiency. Lower net cash flows are associated with more related-party transactions. Both of these observations indicate deficiencies in corporate governance. A model of the prospect of corporate governance reforms can generate predictions on stock returns consistent with our empirical findings. They are also consistent with behavioral theories of stock returns.

Keywords: Stock market, return, IPO, investment, cash flow, related party transaction

JEL Classification: G12, G15, G3