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"Complete Circulation" Should not be Abandoned after the Stop of "Share-Reduction through Market"
2002-12-13
Guo Lihong and Zhang Chenghui
On 22 October 2001, China Securities Regulatory Commission hastily suspended the Interim Management Measures on the Reduction of State Shares to Raise Social Security Funds and openly solicited for plans to reduce state shares. Hence came the exceptionally heated debate on plans to reduce state shares, which fully reflected the enthusiasm of all walks of life in society on the development of China’s stock market. Eight months later, the State Council decided to stop the practice of "share-reduction through market" for state shares, and thereon ended the debate. Looking back over the market storm caused by the reduction of state shares, we think it is an absolutely correct decision to stop the practice of state share reduction through market. Its significance lies in two areas. First, it corrected the mistake in a timely manner, so that greater losses were avoided and a good government image was established. Second, it eliminated the impact of state share reduction and focused the next step on the bottleneck and solution to China’s stock market – the complete circulation of non-tradable shares.
I. It is inappropriate to mix complete circulation with state share reduction.
State share reduction refers to the selling of a part of state-hold shares to recover funds for other usage. However, complete circulation in the stock market means to turn the non-tradable shares of the listed companies (including state shares, legal person shares and internal employee shares) determined at their initial listing stage into tradable shares, so as to thoroughly eliminate the segregation of the stock market. These are two completely different issues with different natures, objectives and operation methods. Therefore, they must not be mixed as one issue. Superficially, continuous effort to reduce state shares may also lead to complete circulation eventually. However, such an assumption is effectually not achievable. The reasons include the followings:
First, in the segregated market, it is impossible to find reasonable pricing benchmarks for state shares intended to sell. As a result of different issuing prices for tradable and non-tradable shares, there are two sets of interests assessment systems and different value standards for the holders of the two different kinds of shares. Consequently, the market prices for shares are not value indicators of all shareholders, nor are they the benchmark prices of non-tradable shares. Under this situation, selling state shares at market prices is nothing else but plundering the holders of the tradable shares (see Zhang Weixing and Zhang Chenghui, "Market Segregation is the Root of All Problems of China Stock Market", Research Report of Development Research Center of the State Council, No. 28, 2002). Therefore, it can only result in market slumps. However, it is also difficult to be scientific and fair to reduce state shares based on other price measurements (such as net assets). For, such practice will easily accelerate speculative manipulations, and harm both the common investors and the interests of the state shareholder (For example, the representatives of the state shareholders can gang up with speculators to hold down the value of net assets with illegal means, and then raise the value after the state shareholders have exited. There has been repeated use of such manipulative methods in the securities market, which have long been practiced skillfully by speculators).
Second, state share reduction is by nature to allow a part of non-tradable shares to start circulation first. If such a practice, which is characterized by partial and local reform first and cross-the-board reform later, may be successful in other fields, it will never succeed in the stock market. For, the stock market is highly liquid and sensitive, where a tiny problem of the "experiment" will generate certain expectation in the whole market and trigger off rapid respond. Especially, with a proportion of 2/3, the large amount of non-tradable shares is like the sword of Damocles hanging above the heads of investors, which will inevitably generate huge psychological pressure on the latter. Moreover, as state share reduction cannot be completed in one effort, it will give rise to various imaginations on the future plans of state share reduction. With expectation for policy changes to happen at any time, the market will be even more unstable.
Third, the non-tradable state shares will not be sold out completely; or else the withdrawing strategic adjustment of the state economy and the "strengthening combined with withdrawing" will become an empty talk. Under this situation, to realize complete circulation through reduction of state shares is hopeless and virtually unachievable.
The above analysis shows that complete circulation and "state share reduction through market" are two different concepts, which should not be mixed together, nor be abandoned together when one is abolished.
II. The root of various problems of China’s stock market lies in market segregation, and only by solving the problem of complete circulation can other problems of China’s stock market be possibly solved.
The segregation of China’s stock market started with the administrative stock issuance system. At the initial stage of the establishment of the stock market, relevant department formulated principle stipulations on the equivalent share value of state assets in the listed companies, the transfer conditions and the premium rates of issued shares, in order to guarantee state control over listed companies and to prevent the depletion of state assets. Through practices thereafter, these ambiguous stipulations created such customary rules as listed below. (1) The share structure of the joint stock companies is defined to consist of four kinds of shares, namely, the state shares, legal person shares, public shares and foreign shares; and the proportion of the first two kinds of shares generally take up 2/3 of the total. (2) State shares cannot be traded freely in security exchanges like public shares, and legal person shares can only be transferred among legal persons. (3) Share prices based on net state assets before share issuance should not exceed RMB1.54 per share, while the premium of publicly tradable shares are significantly higher than the issuing prices of state shares.
Although this unique system design has its historical necessity, it has tinted China’s stock market with the characteristics of the planned economy since the very beginning. By establishing the administrative force (not the market force) as the principal force dominating the market, it has distorted the development of stock market.
To begin with, it is the administrative departments (instead of sponsors of listed companies) who decide on the equity structures of China’s stock market. Such practice does not only restrict shareholders’ rights to make their own decisions on investment, but also divides them into different categories for different treatments. Based on the prices per share paid by various investors, different investors enjoy different rights and share different obligations, thus laying down the unequal basis at the initial establishment stage of joint stock companies.
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