Corporate Finance: Theory and Practice in China

Editor's note: A China-focused investment vehicle available to U.S. investors is the iShares FTSE/Xinhua China 25 Index Fund FXI. Its current top five stock holdings are China Mobile CHL, Industrial and Commercial Bank of China (no ADR ), China Life Insurance LFC, PetroChina PTR, and China Construction Bank (no ADR).

China's stock market has been on a roll. In 2006, all the indices of the Shanghai Stock Market Exchange and the Shenzhen Stock Market Exchange doubled. In 2007, the main indices doubled again. These days, however, the market is trying to digest several companies' financial behavior. In November 2007, China Oil, which had already been listed on the Hong Kong market, came back to issue A shares on the Shanghai Stock Exchange. The opening price was about 48 yuan ($6.70). Now it is below 24 yuan ($3.30). The Shanghai index has fallen from above 6000 to 4500, a 25% loss within three months. Last month, Pin An of China, a major insurance company, announced its 150 billion yuan (US $20.8 billion) financing plan, and the market responded by falling 7% in one day.

Li Yue, Xiong Dehua, Zhang Zheng and Liu Li, four faculty members at the Guanghua School of Management at Peking University, have led a research team from Peking University to explore the financial behavior of companies listed on China's stock exchanges. Last November, the team published a paper titled, "Corporate Finance Theory and Practice: Evidence from China's 167 Listed Companies" based on their findings. China Knowledge@Wharton recently interviewed Professor Li Yue and Zhang Zheng about their research.

The team sent out survey questionnaire forms through the mail or by fax to 1507 Chinese listed companies. The goal of the research was to better understand how Chinese companies behave when they make decisions about their capital budgets, the cost of capital and financing methods in the capital markets . Their research "can improve knowledge about the motivation behind financial decisions made by China's listed companies," says Zhang Zheng.

The researchers also studied the factors affecting these financial behaviors. "There have been only a few survey studies [done on] China's corporate finance. One merit of our research is that the survey is performed independently by an academic institute rather than the government, which makes the results more reliable and meaningful," says Li Yue. China's capital market "is still immature. Most theories in corporate finance are based on mature economies. The research on a new market, such as China," offers a unique contribution to this field of study, notes Zhang.

Among the 1507 companies surveyed, 167 returned the forms. Among those 167 companies, 46 are from the manufacturing industry. The sample of non-manufacturing companies covers almost all kinds of business, including retail, wholesale, mining and construction, transportation, energy, real estate, communication and media, finance, medicine and high-tech. More than 50% of the sampled companies are large companies, with sales greater than one billion yuan (US $139million). For 85% of the sampled companies, the latest three-year average PE ratios are greater than 20. In terms of financial leverage , the rate of assets and liabilities range from 4.7% to 114%. In addition, 70% of the sampled companies are graded as AA or above. In terms of the type of controlling share holdings, 70% of the sampled companies are national holding, 24% are domestic private holding and 1.85% are foreign holding.