Liberalization Policy Implementation and the Cost of Lending
By Lam Swee Sum & Weina Zhang
December 2014

Abstract:

We examine the implementation of financial market liberalization policies in China from 1999 to 2009. We find that the implementation is experimenting in nature. It is beneficial to the financial market when the liberalization policies are implemented in a consistent and speedy manner. Such implementation is associated with the decline in the term premium and the volatility of the lending rate in the interbank repo market. When the liberalization policies are tracked back after a long delay, the term premium and the volatility both increase. Overall, our results suggest that the implementation process of government policies significantly affects the cost of lending.


Unveil the Rationale of Policy Experimentation: The China Experience

By Lam Swee Sum, Tao Li & Weina Zhang
December 2014

Abstract:

The developing Chinese economy has gone through significant market reforms in recent decades. After scanning through more than 100 financial market liberalization policies from 1999 to 2009, we discover that Chinese policymakers are purposefully taking a policy experimentation approach in making new policies, whereby many policies are reversed and re-launched. Intrigued by such a bold policymaking approach, we explore the rationale behind these policy flip-flops. We find that the policymakers are often torn between promoting economic growth and reducing excessive volatility associated with growth. By employing the Chinese interbank repo rates, we propose a simple empirical procedure to evaluate the policy shift on a timely and objective basis. We believe that the Chinese lesson is valuable for other developing economies that are in dire need of promoting economic growth through good policymaking.


Corporate Governance in Chinese Real Estate Firms

By Gang-Zhi Fan, Zsuzsa R. Huszar, & Weina Zhang
October 2014

Abstract:

We show that the traditional western style corporate governance tools are ineffective in Chinese real estate firms from 2000 to 2012. Instead, we find evidence of effective state governance such as corruption cleanup and financial market liberalization. Specifically, the less state-connected firms experience better performance in provinces with greater corruption prosecutions and after 2006 with accelerated stock market liberalization. Overall, our results suggest that the Chinese real estate industry is becoming more market-oriented with the state's assistance.
Note: Published http://www.ires.nus.edu.sg/workingpapers/IRES2014-006.pdf


Does Policy Risk Mater for International Equity Markets?

By Lam Swee Sum & Weina Zhang
February 2014

Abstract:

We test whether policy risk affects international equity returns. We construct two global policy risk factors based on the ratings from international country risk guide. They capture the potential policy shock from government changes and the bureaucratic ability to reduce policy shocks. Both factors significantly affect equity returns in 49 countries from 1995 to 2006 and the bureaucratic factor carries an annual risk premium of 8 percent. The economic and institutional conditions within a country affect the return relation with the policy risk. China is the only country that has low policy risk exposure to government change but high risk exposure to bureaucratic ability. Overall, our study reveals the significance and distinct characterization of policy risk in international equity markets.


Five-Year Plans, China Finance and Their Consequences

By Oliver Zhen Li
March 2015

Abstract:

Examining China's strategic five-year plans during 1991-2010, we find that state-owned firms in government supported industries enjoy faster growth in initial public offerings and higher offer prices. Further, they enjoy faster growth in loans granted by major national banks. However, this preferential access to capital by state-owned firms appears to be achieved at the expense of non-state-owned firms which are crowded out. Government support induces more investment but also brings more overinvestment, which mainly comes from the non-state sector. Finally, supported industries have higher stock market returns and cash flow growth that dampen when state ownership increases. However, government supported industries have a higher ratio of non-performing loans.


Political Ranks, Incentives and Performance

By Oliver Zhen Li
March 2015

Abstract:

China's state-owned firms have a unique form of governance – governance through political ranks of its top executives. We find that this form of governance is effective in motivating top managers and enhancing firm performance. Specifically, the higher is the level of top managers' political ranks, the better is firms' financial performance. This study helps us understand China's unique approach in corporate governance.


China's Closed Pyramidal Managerial Labor Market and the Stock Price Crash Risk

By Oliver Zhen Li
March 2015

Abstract:

Managers of China's state-owned firms work in a closed pyramidal managerial labor market. They enjoy non-transferable benefits if they choose to stay within this system. The higher up are they in this labor market hierarchy (their political ranks), the fewer are their outside employment opportunities. Due to career and wealth concerns, they exhibit prudence in managing firms. We examine the effect of managers' political ranks on firms' stock price crash risk and find a negative association between them. Further analysis shows that this association mainly exists in firms with younger managers and managers with shorter tenure. We extend the literature on stock price crash risk by showing that the contract between the state and managers is another important determinant of the stock price crash risk.


Did China's Adoption of IFRS Attract More Foreign Institutional Investment?

By Oliver Zhen Li
March 2015

Abstract:

We examine the impact of China's IFRS adoption on foreign institutional investment. We find that foreign institutional investment does not increase after China's IFRS adoption, and some evidence that it actually declines, particularly among firms with weaker incentives to credibly implement IFRS, or with greater ability to manipulate IFRS's fair value provisions. We also find that the association between earnings and returns generally declines after IFRS adoption, consistent with reduced earnings quality. In addition, we find that foreign institutional investors' returns decrease after China's IFRS adoption. Finally, the decline in foreign institutional investment is greater among investors from countries with weak institutions that have also adopted IFRS. Taken together, our evidence suggests that China's weak institutional infrastructure impairs IFRS's ability to improve financial reporting quality and increase foreign institutional investment.


Perk Consumption as a Suboptimal Outcome Under Pay Regulations

By Oliver Zhen Li
March 2015

Abstract:

We examine how perk consumption is determined and whether it impacts firm value in China where executive pay is regulated. We find that perks are provided when the relative pay between top executives and average employees is low, in firms with high free cash flows, economic rent and growth. Perks are positively associated with firm value, but to a much lesser extent than monetary compensation. This suggests that if perks are converted to cash compensation, shareholder wealth can be further enhanced. However, under China's regulated compensation structure, this conversion may not be easily achieved and perks likely represent a second-best suboptimal solution in motivating executives.


Controlling Shareholders' Incentive and Corporate Tax Avoidance – A Natural Experiment in China

By Oliver Zhen Li
March 2015

Abstract:

The split share structure reform that started in 2005 removed a significant market friction in China's capital markets by allowing previously non-tradable shares to be freely tradable at market prices. Such a reform reduces the agency conflict between controlling shareholders and minority shareholders as the former now care more about stock prices, thus aligning their incentive with that of the latter. We find that state-owned firms, but not non-state-owned firms, significantly increase their tax avoidance activities after the reform. We attribute this differential effect to the dual role of the government as state-owned firms' controlling shareholder as well as the tax claimant. Further, this effect is more significant for state-owned firms that are more likely to be influenced by the government. Finally, the reform appears to reinforce a positive association between tax avoidance and firm value. Overall, our study suggests that when controlling shareholders are more concerned about stock prices, state-owned firms become more engaged in tax avoidance activities to enhance their share value.

Individual Investors' Dividend Tax and Corporate Payout Policies – Evidence From A Reform That Ties The Dividend Tax Rate To Share Holding Period
By Oliver Zhen Li
March 2015

Abstract:

The 2012 Dividend Tax Reform in China uniquely ties individual investors' dividend tax rates to the length of their share holding period. We find that firms facing a reduction in their individual investors' dividend tax rate are more likely to increase dividend payout, initiate dividends, and are less likely to omit dividends, compared with firms facing an increase in their individual investors' dividend tax rate. Such an effect is concentrated in firms with a low level of agency cost. In addition, investors respond to this tax law change by reducing trading activities before the cum-dividend day to avoid entering into a higher dividend tax bracket. Further, stock return patterns on the ex-dividend day suggest that reduced trading activities lower the marginal investor's dividend tax penalty. Overall, our evidence enhances the notion that individual investors' tax profiles shape firms' payout policies.


Do Employers Respond to Tax Incentives? – Evidence from the Hiring of People with Disabilities

By Oliver Zhen Li
March 2015

Abstract:

Tax subsidies have often been used to provide incentives for firms to hire people with certain attributes, including those with disabilities. In 2007, China drastically changed its tax law on disability hiring. Before 2007, disability hiring was mainly borne by the so called "welfare firms" and the tax subsidies that they received were in lump-sums and not per capita based. The new tax act closely ties tax subsidies that a firm receives to the number of its employees with disabilities on a per capita basis and expands tax subsidies to also cover "non-welfare firms". We find that welfare firms reduce disability hiring while non-welfare firms increase disability hiring after the tax act, consistent with their altered tax incentives. We also show that firms manipulate disability hiring to maximize the amount of tax subsidies that they receive. Further, the efficiency of using tax subsidies to induce welfare firms to hire people with disabilities improves after the tax act. However, a seemingly unintended consequence of efficiency enhancement is a decline in the total number of employed people with disabilities.

Capital's Sin and China's Fleeing Entrepreneurs – Foreign Residency Rights and Corporate Frauds
By Oliver Zhen Li
March 2015

Abstract:

We examine whether Chinese firms whose controlling persons have foreign residency rights are more likely to engage in corporate frauds. We find a positive association between foreign residency rights and corporate frauds with causality likely going from the former to the latter. Executive share ownership and analyst coverage mitigate this association. Our finding is robust to a matched-sample analysis aimed at addressing self-selection, and to the usage of a bivariate probit model with partial observability that incorporates undetected frauds. Our study suggests that Chinese regulators and investors should pay attention to potential culprits with foreign residency rights and that foreign governments should exercise caution when granting residency status to foreigners.


Of Poetry and Ethics

By Oliver Zhen Li
March 2015

Abstract:

Ethics is valuable to the society and can be an important factor that contributes to good governance. However, selecting people on ethics can be a challenging task. We argue that poems reflect poets' ethic principles and reveal their personal utility functions. Therefore, poetry can be a good screening device to evaluate people on the ethics dimension. We hypothesize a positive association between poetry and ethics. Ancient China had a practice of selecting civil service government officials based on the artistic quality of their poems. Using historical archival records of civil service officials' ethics and the artistic quality of their poems during China's Tang Dynasty, we empirically establish a positive link between poetry and ethics. As governance through ethics is an important alternative to governance through incentives, our study sheds light on a selection mechanism based on people's internal value system as opposed to an external transaction-based system.

Particles, Pollutions and Prices
By Oliver Zhen Li
March 2015

Abstract:

We investigate whether a sentiment effect arising from poor air quality impacts stock prices. We find little evidence suggesting that local air quality directly affects stock prices. However, we show that the local air quality index (which is increasing in air pollution) relative to that of Beijing negatively affects stock prices. We apply a discontinuity design that focuses on observations with relative air quality index falling in the narrow band around zero and find a consistent result. Additional analysis unveils a subsequent reversal in returns in response to the relative air quality. Further, the relative air quality index also negatively affects trading volume. Finally, we show that the negative association between stock prices and the air quality index is not influenced by economic fundamentals or investor sophistication. In sum, our findings suggest that poor air quality negatively affects stock prices and investor trading activities.


The Nightmarish Dream of the Red Chamber – A Statistical Analysis of Social Network and Family Governance
By Oliver Zhen Li
March 2015

Abstract:

The current corporate governance research has already introduced a social network or socioeconomic perspective into the analysis. Family firm governance research, as a part of corporate governance research, is also flourishing. However, family governance research has yet to emerge. China's classic literary work, Dream of the Red Chamber, which transitions between realities and imaginations, reflects current phenomena and mentalities.  Dream of the Red Chamber is a masterpiece full of vivid characters in complex social and economic settings. It reflects multiple dimensions of the society and families. Our empirical analysis of Dream of the Red Chamber provides us with an opportunity to understand family governance. Analysing the 400 plus characters' salaries, status, rewards, punishments and outcomes with respect to their factions, political affiliations, seniority, lineage, affinity and personal intimacy, we discover the importance of social network in family governance. Furthermore, these characters' educational background, poetry, religion and ethics moderate this relationship. This research helps us decode the secrets of family governance. More importantly, it helps Chinese understand themselves better – as a people and as a society.

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