Reverse Mergers, Shell Value, and Regulation Risk in Chinese Equity Markets

68 Pages Posted: 19 Sep 2017 Last revised: 19 Oct 2017

See all articles by Charles M.C. Lee

Charles M.C. Lee

Stanford University - Graduate School of Business

Yuanyu Qu

University of International Business and Economics (UIBE) - School of Banking and Finance

Tao Shen

Tsinghua University

Date Written: September 9, 2017

Abstract

Using a comprehensive sample of reverse merger (RM) transactions, we examine the effects of China’s IPO regulations on the prices and returns of its publicly listed stocks. During 2007-2015, unlisted Chinese firms paid an average of 3 to 4 Billion RMB for each listed shell, an amount exceeding 2/3 of the median market capitalization of a listed firm. This large shell premium varies over time and is sensitive to regulatory shocks. In the cross-section, a portfolio that longs (shorts) the highest (lowest) estimated shell probability (ESP) firms earns substantial abnormal returns. Adding an ESP-based factor to five common factors improves return attribution and eliminates the notoriously large Size premium. Consistent with theory, ESP also explains the sensitivity of prices to corporate earnings, and predicts the likelihood of firms to undertake major asset restructurings (MARs). We conclude China’s IPO regulations impose a high cost on the functional efficiency of its financial system.

Keywords: reverse mergers, shell value, anomalies, regulation risk, IPOs, Chinese equity markets.

JEL Classification: G12, G02, G18, G34

Suggested Citation

Lee, Charles M.C. and Qu, Yuanyu and Shen, Tao, Reverse Mergers, Shell Value, and Regulation Risk in Chinese Equity Markets (September 9, 2017). Stanford University Graduate School of Business Research Paper No. 17-63. Available at SSRN: https://ssrn.com/abstract=3038446 or http://dx.doi.org/10.2139/ssrn.3038446

Charles M.C. Lee

Stanford University - Graduate School of Business ( email )

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States
650-721-1295 (Phone)

Yuanyu Qu

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Tao Shen (Contact Author)

Tsinghua University ( email )

Department of Finance
School of Economics and Management
China

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