The Behavior of China s Stock Prices in Response to the Proposal and Approval of Bonus Issues

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1 The Behavior of China s Sock Prices in Response o he Proposal and Approval of Bonus Issues Michelle L. Barnes a* and Shiguang Ma b a Federal Reserve Bank of Boson Research, T Alanic Avenue Boson, MA USA b Universiy of Adelaide School of Economics Adelaide, SA 5005 Ausralia April 2002 Absrac: Even sudy analysis is applied o invesigae sock price reacion o he announcemen of bonus issues for he emerging sock markes of China. Resuls show ha he issues wih a high bonus raio (number of bonus shares in he issue/number of exising shares) usually arac posiive reurns for boh Chinese (A-share raders) and foreign (B-share raders) residens. Issues wih a low bonus raio are rewarded wih negaive reurns for A-share raders and do no simulae significan aciviy by B-share raders. The hypohesis of semi-srong form marke efficiency is rejeced only for small-bonus issues raded on he A-share marke; he B-share marke displays sronger evidence of semi-srong form marke efficiency han he A-share marke. Finally, here appears o be addiional informaional conen in he approvals of bonus issues above and beyond ha of he proposals, even hough mos bonus schedules proceed as proposed. Key Words: Chinese Sock Markes; Efficien Marke Hypohesis (EMH); Semi-Srong Form Efficiency; Even Sudy; Announcemens of Proposal or Approval; Underreacion and Overreacion. JEL Classificaion: G14; G18; O16. * Barnes s is and Ma s is Barnes is he corresponding auhor. Ma would like o hank paricipans from he 1999 Ph.D. Conference in Economics and Business, Perh, Ausralia, All errors are he auhors own.

2 1. Inroducion According o he Efficien Marke Hypohesis, if he sock prices reflec he announcemen of public informaion insananeously and wihou bias, he marke should be classified as semisrong form efficien (Fama 1970). Generally, he invesigaion of semi-srong form marke efficiency has been limied o he sudy of well-developed sock markes. In his paper, we use he even sudy mehodology (Dolley 1933; Fama e al. 1969; and Brown and Warner 1980, 1985) o examine his issue for he sock marke of a ransiion economy: China. China s Sock Marke (CSM) is an emerging marke wih wo sock exchanges. The Shanghai Sock Exchange was esablished in December 1990, and he Shenzhen Sock Exchange was esablished in April A-shares and B-shares rade on boh of hese exchanges. Officially, A-shares are accessible by Chinese residens wih Chinese currency, while B-shares are limied o foreign invesors wih U.S. dollars on he Shanghai marke and Hong Kong yuan on he Shenzhen marke. Before April 2001, however, many Chinese residens raded B-shares by using foreigners accouns or opened B-share accouns by using foreigners passpors. No exac number is officially repored, bu i has been esimaed ha abou half of he B-share marke s ransacions involved Chinese residens. 1 CSM has developed rapidly for he pas en years. By July 2000, here were 1,004 lised companies wih marke capializaion of 4,000 billion renminbi (RMB). 2 Even sudy analyses are ypically used for wo differen purposes: as a es of semi-srong form marke efficiency; and assuming ha he marke efficiency hypohesis holds, as a ool for examining he impac of some even on he wealh of firms shareholders. This paper provides an iniial invesigaion of he Chinese sock price behavior in reacion o he announcemen of bonus issues using even sudy echniques. 3, 4 Alhough he analysis focuses on he issue of wheher or no he hypohesis of semi-srong form efficiency holds, i also demonsraes he differing price and hence shareholders wealh responses o he announcemens of large-bonus and small-bonus issues proposals and approvals respecively. Also, i is possible o evaluae 1 In April 2001, he Chinese B-share marke was opened o Chinese residens, who had foreign currency, U.S. dollar or Hong Kong yuan. 2 In July 2000, 1 U.S. dollar was equal o abou 8.3 renminbi. 3 To he bes of he auhors knowledge, no similar sudy has been performed on he Chinese sock markes. 4 The auhors have relaed papers on he announcemens of zero-dividend issues, cash-dividend issues, and righs issues. 1

3 wheher or no he bonus approval has addiional informaional conen above and beyond ha of he proposal. Bonus sock is usually issued upon approval according o he schedule adverised in he proposal. The peculiar A-share/B-share srucure of he CSM enables examinaion of wheher public informaion is incorporaed ino prices differenly across hese wo markes and groups of raders. Alhough B-share raders are no composed enirely of foreign raders, we refer o raders who rade in his marke as foreign. The public informaion considered here is boh he proposal and, separaely, he approval of bonus issues of common sock o exising shareholders. In principle, his public informaion could be incorporaed ino prices differenly across he A- share and B-share markes given ha he B-share marke consiss of a large proporion of foreign raders and he A-share marke consiss enirely of Chinese residens. Differen residency may affec how he marke paricipans incorporae informaion ino share prices. The informaional impor of he bonus announcemens and approvals may differ depending on he shareholder s counry of residence due o differen ax and oher insiuional arrangemens. A bonus issue is a free issue of shares, wihou a subscripion price, made o exising shareholders in proporion o heir curren invesmen. A firm can disribue bonus shares by using reained earnings (also known as sock dividends) or accumulaed capial reserves. In China, he majoriy of companies prefer o issue he bonus from accumulaed capial reserves, or from a combinaion of boh capial reserves and reained earnings. Miller and Modigliani (1961) demonsraed heoreically ha bonus issues, along wih oher ypes of dividends, do no aler shareholder wealh. If a company plans o finance a bonus issue from reained earnings, i makes a book enry o allocae reained earnings ino paid-up capial in he shareholders equiy secion of he company balance shee. Alernaively, a company ha decides o realize a bonus issue by using accumulaed capial reserves adjuss he accumulaed capial reserves ino paid-up capial. The company does no receive any cash and is financial posiion remains he same. The modificaion riggered by he bonus issue is ha he number of ousanding shares is adjused by he bonus issue raio, herefore, he price of he shares declines according o he same bonus issue raio. 5 The oal marke value of he shares or he value of he 5 Bonus raio is he number of bonus shares in he issue/number of exising shares applicable for he bonus issue. 2

4 shares ha are held by each invesor should remain unchanged. Sloan (1987) provided Ausralian evidence ha bonus issues do no affec shareholders wealh. In pracice, however, here may be an increase in share price following he announcemen of a bonus issue. Such an increase can occur because he announcemen of a bonus issue may have beneficial informaional conen (Peerson 1971). Shareholders are aware ha, afer he bonus issue, companies usually increase oal dividend payou. This, in urn, indicaes he confidence of managemen in he company s fuure. Consequenly, he share price may increase in response o his informaion and affec shareholders wealh. The informaional link beween dividends and earnings is suppored empirically by Healy and Palepu (1988). They show ha firms ha iniiae dividends have significan increases in earnings for a leas one year afer he announcemen. Grinbla, Masulis, and Timan (1984) provide evidence of significanly posiive announcemen reurns for boh sock splis and large sock dividend announcemens for he American share markes. One poenial hypohesis hey provide for his evidence is he so-called reained earnings hypohesis. Wih sock dividends, he value of he newly issued shares is subraced from reained earnings and added o he firm s capial accoun. If he firm mees consrains ha are a funcion of reained earnings such as legal resricions, sock exchange rules, or bond covenans, he bonus shares can inhibi he firm s abiliy o pay cash dividends. Firms expecing posiive fuure performance will no expec hese consrains o be binding, so hey do no mind reducing reained earnings. Firms ha do no expec o do well would find hese consrains binding and hence would choose no o issue more shares. They argue ha for American companies, for which generally acceped accouning principles dicae ha sock disribuions of 20% or less are aken ou of reained earnings while sock dividends in excess of 25% are reaed as sock splis, his signaling argumen is inappropriae. This accouning convenion does apply o Chinese companies, hough, so his may remain a viable hypohesis for he CSM. 6 Also, managemen may believe ha reducing he marke price per share o a reasonable level faciliaes rade in he company s shares and ha his in urn may increase he demand (he so-called rading range hypohesis ). If his were rue, he marke value of he company s 6 Grinbla, Masulis, and Timan (1984) provide a nice discussion of he alernaive hypoheses consisen wih his observed empirical phenomenon, such as he rading range hypohesis discussed below. They also deail disadvanages o all of he hypoheses hey survey. 3

5 equiies and hence shareholders wealh again would increase. An alernaive way o reduce marke price per share is a sock spli, which represens a reducion in he par value. 7 The essenial difference beween a bonus issue and a sock spli is ha a sock spli need no be accompanied by a book enry o relocae he reained earnings or accumulaed reserves ino paidup capial in he shareholders funds secion of he company balance shee. 8 According o Chinese regulaions, shareholders mus pay ax for a cash dividend bu no for a sock dividend, in oher words, hey need no pay ax on he bonus, which makes he bonus more favorable han a cash dividend. In addiion o his insiuional advanage and o he reained earnings hypohesis, here is some anecdoal evidence peraining o China ha suggess large-bonus issues signal ha managemen is confiden abou he company s fuure growh opporuniies. 9 However, his may no mean ha he Chinese shareholders (A-share raders) welcome all bonus issues. In fac, our resuls demonsrae ha Chinese shareholders preference is for a high bonus raio raher han a low bonus raio. Apparenly, he low bonus raio does no convey he same informaional conen as he high bonus raio o hese raders. In conras, foreign shareholders of Chinese shares (B-share raders) do no reac significanly o he announcemen of small-bonus issue approvals. These wo groups of raders view he informaional conen of small-bonus issue approvals differenly. However, boh groups of raders respond posiively and significanly o he announcemens of large-bonus issues, lending suppor o he reainedearnings-ype hypohesis. A-share raders respond more dramaically o his informaion hough. The only evidence we find of semi-srong form marke inefficiency is for he A-share marke s response o he announcemen of small-bonus issue proposals. Oherwise, he evidence suggess ha boh he A-share and B-share markes respond o he announcemen of bonus issues by efficienly incorporaing his informaion ino he share price. Under he mainained hypohesis of semi-srong form marke efficiency, large-bonus proposals and approvals end o 7 However, as poined ou by Grinbla, Masulis, and Timan (1984) managers of overvalued firms wih no favorable inside informaion migh spli simply in order o ge a emporary price increase. 8 Fama e al. (1969) in heir classic sudy examined 940 sock splis on he NYSE beween 1927 and In heir sudy, reurns are higher immediaely following he announcemen of he splis. There is no evidence ha abnormal reurns are available due o price overreacion or underreacion o he announcemen. 4

6 increase shareholder wealh for boh groups of raders. In addiion, small-bonus issues end o decrease A-share holders shareholder wealh, and have no impac on shareholder wealh for B- share raders. The paper is organized as follows. The nex secion describes he mehodology employed in his paper and he CSM daa. Secion 3 discusses he resuls of he srong-form marke efficiency ess on he announcemen of bonus proposals for A-shares, and heir impor for shareholder wealh. Secion 4 similarly analyzes he announcemen of bonus approvals for A-shares. Secion 5 examines he oucomes of he ess on he announcemen of bonus approvals for B-shares, and Secion 6 concludes his paper. 2. Mehodology and Daa 2.1 Even Sudy and he Models The sandard mehodology used o evaluae he reacion of share prices o public announcemens is an even sudy, which was employed as early as 1933 by Dolley. Over he pas half cenury, even sudies have been employed in much research and heir sophisicaion has been grealy improved by auhors such as Fama e al. (1969) and Brown and Warner (1980, 1985). 10 To consruc an even sudy, he even, even window, esimaion window, esimaion model, and invesigaion window should be deermined. The even is wha he invesigaors would like o sudy, and i conveys informaion ha poenially influences he sock prices. The evens defined for his sudy are he announcemens of bonus proposals or bonus approvals. An even window is he period in which an even occurs. Sricly speaking, an even window should be a period when he occurrence of he even is publicly announced. In he case ha he even is announced afer rading hours and hen impacs on he nex day s prices, or ha here is a ime difference in he announcemens in differen news media, he even window is expanded o hree days. Thus, he even window in his sudy is combined wih he day of he announcemen and he days preceding and succeeding he announcemen day, which are numerically expressed as 1, 0, +1. The period of daa used in 9 The research direcor of one of China s larges fund companies affirmed his is indeed he case and ha high bonus issues signal poenial expansion of he company, whereas small-bonus issues do no. 10 Please refer o MacKinlay (1997) and Binder (1998) for excellen surveys of he even sudy mehodology. 5

7 he esimaion of parameers is known as an esimaion window. The esimaion window in his sudy is defined from he day 150 o he day 21 before he announcemen dae 0. In an even sudy, boh he abnormal reurns occurring during he ime of he even window and he abnormal reurns occurring in he periods around he even window mus be invesigaed. The abnormal reurns occurring in an inerval before he even window reveal wheher he marke has anicipaed he informaion conained in he even (or here has been rading on inside informaion). The abnormal reurns in an inerval afer he even window can ell us wheher he marke overreacs or underreacs o he announcemen of he even. The invesigaion window in his sudy is an exension of he even window, from day 20 hrough day +20. The seleced examinaion models for his sudy are he marke-adjused model and he marke model. The marke-adjused model is r i, rm, + ε i, =, where r i, is he reurn of sock i a day, marke porfolio or a marke index, 11 and r m, is he marke reurn a ime, as calculaed from a ε i, is he abnormal reurn of sock i a day. Thus, he marke-adjused model assumes ha he normal reurns are equal across all socks a ime, bu no necessarily consan for a given securiy a differen imes. The abnormal reurn on any sock i is deermined by he difference beween is reurn and ha on he marke porfolio simulaneously, ε i, = r i, rm, The marke model is. r i, = α i + βirm, + εi,, where α i is he inercep erm, and β i measures he marginal effec of he marke reurn on he reurn of sock i. Here, he parameers of he marke model are esimaed from a regression of he 11 Since here is no an index across boh he Shanghai and Shenzhen markes and here is segmenaion of he A-share and B-share markes, he SSE-A, SZS-A, SSE-B and SZS-B will be employed as marke indices when we es Shanghai A-shares, Shenzhen A-shares, Shanghai B-shares and Shenzhen B-shares respecively. 6

8 reurns on a sock and he marke porfolio in he esimaion window, days 150 hrough The abnormal reurn (residual) on any sock i in he even window (or invesigaion window) is measured by he difference beween is acual reurn and he prediced reurn. Hence: ε = αˆ + βˆ, i, r i, i irm, where ˆ i, β i are he esimaes of α i, β i α ˆ. The -saisic for abnormal reurns on an even dae, in his case, = 1, 0, +1, is sˆ ( ε ) * = ε, where ε is average abnormal reurn of socks involved in he es a day, and sˆ ( ε ) is he corresponding sandard deviaion. Mahemaically, we have: where of 1 N 21 2 ε = ε, and sˆ( ε ) = [ ( ε ε ) ] 129, N i= 1 i, = 150 N is he number of socks involved in he es a day, ε is he average abnormal reurn N socks from day 150 o day 21, such ha 1 21 ε = ε. 130 = 150 Masulis (1980), Brown and Warner (1985), and Corrado and Zivney (1992) have used hese saisics. The -saisic for abnormal reurns in an inerval is b 2 [ ˆ ( ε ] b, b ) = a = a 1/ 2 a = ε s. The firs and las days of he inerval are a and b, which are seleced as 10 o 0, 10 o +10, 0 o +10, and so forh in his sudy. ε and sˆ ( ε ) are he same as before. 13 In case of a skewed disribuion of abnormal reurns, we also apply a nonparameric rank es on he even dae. The -saisic (Corrado 1989) is 12 Binder (1998) suggess ha he marke model esimaor of he average abnormal reurn is usually unbiased and efficien when eiher a large sample of unrelaed securiies is sudied or even daes are no clusered in calendar ime, as would be he case in he presen sudy. 13 Campbell, Lo, and MacKinlay (1997) also formulae his -saisic, in marix noaion. 7

9 k = 1 N N l + 1 ki, i= 1 2 s ( k ), where k i, denoes he rank of an abnormal reurn ε i, in an abnormal reurn ime series. l is he number of abnormal reurns in he ime series. In his paper, he ime series is consruced by 170 abnormal reurns in he esimaion window plus he invesigaion window (including he even window). Therefore he expeced rank of an abnormal reurn should be ( l +1) / 2 = 85.5 in his rank es. Thus N ( k ) = ( k 85.5 s i, ). 171 = 150 i= 1 N All of he ess in he even sudies are conduced a he 5% or 1% significance level. Corrado and Zivney (1992) show ha he -es is dominaed by he performance of he rank es in he case of nonsymmeric disribuion of securiy excess reurns Daily Sock Reurn Daa and Porfolio Consrucion Previous lieraure exhibis he use of boh monhly and daily sock reurn daa employed in even sudies. For example, Fama e al. (1969), and Brown and Warner (1980) used monhly sock reurn daa, whereas Scholes (1972), Corrado (1989), and Frankfurer and Schneider (1995) used daily sock reurn daa. Theoreically, daily and monhly daa may differ in poenially imporan respecs. Firsly, daily reurns depar more from normaliy han monhly reurns (Fama 1976). Too, he esimaion of parameers from daily reurns is complicaed due o nonsynchronous rading (Scholes and Williams 1977). Finally, daily reurns have a smaller sandard deviaion han monhly reurns (Brown and Warner 1985). However, Brown and Warner (1985) showed in heir simulaion ha he nonnormaliy of daily reurns has no obvious impac on even sudy mehodologies. They provided evidence ha he mean abnormal reurns in a cross secion of securiies converge o normaliy as he number of securiies in he sample increases. Their sudy argued ha sandard parameric ess are wellspecified using daily abnormal reurns compued using eiher he marke model or he markeadjused model, and, as expeced, he power of each es is greaer wih daily reurns han wih monhly reurns. In addiion, he use of daily reurns is poenially effecive in ha i permis he 8

10 researcher o ake advanage of precise informaion abou he specific day of he monh on which an even akes place. Using daily daa in his sudy is mos appropriae due o he special characerisics of CSM. By Sepember 2000, CSM had been open for only nine years and he majoriy of companies were lised afer Thus, he sample size for monhly observaions of a sock and he numbers of socks wih sufficien observaions are boh oo small o saisfy he requiremens of he saisical ess. Furher, an assumed esimaion window of 36 monhly observaions covers hree years in which he same even, such as he announcemen of a dividend issue, may happen a leas hree imes. Alhough 36 observaions are sufficien for generaing abnormal reurns for a sudy on dividend issues, in he presen applicaion his esimaion would be biased because of he influences of oher economically significan evens which can occur during his esimaion window. An addiional argumen for using daily over monhly daa is ha he response of sock prices o new informaion is rapid. All of he sock prices in his sudy have been adjused for changes in currency of denominaion, sock splis, dividend issues, bonus issues, and righs issues before he reurns were calculaed. The bonus issues analyzed in his sudy are limied o he period from 1994 o 1998 for he following reasons. Firsly, because neiher he Shanghai nor he Shenzhen sock marke operaed regularly in he period before 1993, he bonus issues of he wo markes had no been deermined by formal regulaion. Secondly, he legislaion negoiaed by each marke had no been unified prior o 1993, so ha he same even on he wo markes may have had differen characerisics. Thirdly, he professional financial newspapers, which are auhorized by he China Securiy Regulaion Commission o publish informaion abou sock markes, were firs issued around he end of The official annual yearbooks of he sock exchanges, which conain he records of relevan evens, were regularly published only afer Therefore, consisen references o evens occurring prior o 1993 canno be obained. In China, he bonus (and oher imporan) issues are scheduled, and he relaed informaion is released as follows. The manager pus forward he suggesion of a proposal o he Board of Direcors. If i is acceped, following he negoiaion beween he direcors on he Board, a scheme of he proposal is filed and will be announced in wo days. Abou hree monhs laer, he proposal is voed on by he Conference of he Represenaives of Shareholders. In general, he 9

11 scheme of he proposal can be approved by he represenaives of he shareholders, and will be announced in wo days immediaely afer he voe. The announcemens are usually published on he noice board of he sock exchange via he ransacion sysem and in auhorized financial newspapers. Consrucion of he porfolios used in his sudy akes ino consideraion several unique aspecs of he CSM. Firsly, sock prices may reac o he announcemens of proposals and approvals in differen ways. Share raders may have differen preferences for he various bonus issues schemes. Secondly, raders in differen counries may value he informaion differenly due o insiuional differences in ax code and he like. For hese reasons, we perform ess on porfolios caegorized in he following fashion. Porfolios are classified on he basis of bonus raio size (small, medium or middle, and large), wheher he announcemen was a proposal or an approval, and wheher he marke rades A-shares or B-shares Tess on he Announcemen of Bonus Proposals for A-Shares A oal of 196 bonus proposals of A-shares are consruced ino hree porfolios. The smallbonus porfolio includes 103 proposals. The middle-bonus porfolio includes 37 proposals. The large-bonus porfolio includes 56 proposals. This sudy considers he differen effecs of he announcemen of bonus proposals for each classificaion of bonus issues. 3.1 A-Shares Reurn Behavior around he Announcemen of Bonus Proposals The resuls of he ess on he announcemen of bonus proposals are summarized in Table-1. Table-1, Panel (a) presens he Cumulaive Abnormal Reurns (CARs) of each porfolio around he announcemen dae of he bonus proposals. Figure-1(1) graphs he CARs measured by he marke-adjused model and Figure-1(2) graphs he CARs measured by he marke model. From hese figures i can be seen ha he CARs of all bonus proposals ( Overall porfolio) a dae +20 are posiive and he relevan lines are above he zero reurn axis. Therefore, on average, he bonus proposals raise posiive CARs around he announcemen dae. Tha he announcemen of bonus proposals, on average, has a posiive effec on China s sock prices coincides wih he 14 Small-bonus porfolios are hose ha include issues wih bonus raios less han or equal o 2 for 10. Mediumbonus or middle-bonus porfolios include issues wih bonus raios larger han 2 for 10, bu less han or equal o 4 for 10. Large-bonus porfolios consis of issues wih bonus raios larger han 4 for

12 evidence of Ball, Brown, and Finn (1977) for Ausralian sock prices. The CARs of an Overall porfolio are by consrucion an aggregae of differen sizes of bonus issues. For deeper undersanding, he analysis is decomposed ino he small-bonus, middle-bonus, and large-bonus porfolios. Table-1. Resuls of he Tess on he Announcemen of Bonus Proposals for A-Shares in China's Sock Marke (a). Cumulaive Abnormal Reurns (CARs) Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Noes: 1. Small: he sample of 103 proposals wih bonus raios less han or equal o 2 for Middle: he sample of 37 proposals wih bonus raios larger han 2 for 10, bu less han or equal o 4 for Large: he sample of 56 proposals wih bonus raios larger han 4 for Overall: he sample of all 196 bonus proposals. 5. Dae 0: he dae of he announcemen. 6. Dae -1 o -20: he daes before he announcemen. 7. Dae +1 o +20: he daes afer he announcemen. 11

13 (b). Parameric and Nonparameric -es Saisics on he Abnormal Reurns for he Specific Even Dae Parameric -es Saisics Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Nonparameric (rank) -es Saisics Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Noes: 1. Dae 0: even dae, he dae of he announcemen. 2. Dae -1: alernaive even dae, he announcemen may occur one day in advance of ha on record. 3. Dae +1: alernaive even dae, he announcemen may occur one day laer han ha on record. 4. If he -es saisic is larger in absolue value han 1.96 or 2.58, he relevan abnormal reurn is saisically nonzero a he 5% or 1% significance level, respecively. (c). Parameric -es Saisics on he Cumulaive Abnormal Reurns (CARs) in Inervals around he Even Dae Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall 11 Days Around Even Day -5 o o o Days Around Even Day -10 o o o Days Around Even Day -20 o o o Noe: If he -es saisic is larger in absolue value han 1.96 or 2.58, he relevan CARs of he inervals are saisically nonzero a he 5% or 1% significance level, respecively. Caegorizing he porfolios by size demonsraes ha he shareholders discriminae agains he small-bonus socks by responding o he small-bonus proposals wih negaive reurns. The CARs of small-bonus socks are negaive a he sar of he invesigaion period and drop markedly afer he announcemen dae. A he dae of +20, he CARs of small-bonus socks decline below 7.0%. Conversely, he shareholders respond favorably o he middle-bonus and large-bonus proposals, resuling in posiive reurns. The CARs of middle-bonus and large-bonus 12

14 socks begin posiively and grow rapidly unil he announcemen dae, and hen remain relaively sable hereafer. A he end of he invesigaion period, he CARs of middle-bonus and largebonus socks are significan and above 7.0% and 11.0% respecively, compared wih 9.6% and 11.56% a he announcemen dae. Figure-1. Cumulaive Abnormal Reurns (CARs) for Bonus Proposals of A-Shares in China's Sock Marke (1). Marke-Adjused Model Cumulaive Abnormal Reurns (CARs) CAR Small Middle Large Overall Dae (2). Marke Model Cumulaive Abnormal Reurns (CARs) CAR Small Middle Large Overall Dae 13

15 Boh he parameric and nonparameric -es saisics in Table-1, Panel (b) sugges ha he share raders reac o he announcemen of bonus proposals a he even daes boh significanly and in suiable direcions. The -values of small-bonus socks are below 1.96 or 2.58 a even daes 0 and +1, which illusraes ha he small-bonus proposals represen unfavorable informaion a convenional levels of significance. Meanwhile, he -values of middle-bonus and large-bonus socks are larger han or a he even dae 0 or a alernaive even dae 1. This implies ha he middle-bonus and large-bonus proposals are considered o be favorable informaion a convenional significance levels. Table-1, Panel (c) shows significanly negaive CARs in he inervals of daes 5 o +5, 10 o +10, and 20 o +20 around he announcemen dae 0 for he small-bonus socks, bu significanly posiive CARs for he middle-bonus and large-bonus socks. Moreover, he significanly negaive CARs are generaed mainly in he inervals of daes +1 o +5, +1 o +10, and +1 o +20 afer he announcemen dae for he small-bonus socks, suggesing underreacion o he unanicipaed bad news. Meanwhile, significanly posiive CARs are generaed mainly in he inervals of 5 o 1, 10 o 1, and 20 o 1 before he announcemen dae for he middlebonus and large-bonus socks, implying ha he marke anicipaed and incorporaed he informaion before he even. The CARs in hese inervals are presened graphically in Figure-1, Panels (1) and (2). 3.2 Assessmen of Marke Efficiency for A-Shares on he Announcemen of Bonus Proposals A he even dae 0, sock prices reac negaively o he small-bonus proposals a he 5% or 1% significance level. However, he -values on he CARs in he inervals of daes +1 o +5, +1 o +10, and +1 o +20 afer he announcemen are below 2.58, which indicaes ha he smallbonus proposed sock prices underreac o he announcemen a he even dae. Thus, here exiss a sraegy permiing abnormally high reurns for he small-bonus sock invesors. Suppose ha he small-bonus shareholders sell heir shares a he announcemen dae and buy he same shares afer 20 days. This sraegy will provide a gain of 6%. 15 Thus, he hypohesis of informaional 15 (( )-( ))*100%=6.05%, abnormal reurns are measured by he marke-adjused model; (( )-( ))*100%=5.91%, abnormal reurns are measured by he marke model. These numbers sill yield abnormal reurns even afer allowing for a 0.30% ransacion fee. 14

16 efficiency for he small-bonus sock is refued. Furhermore, hese resuls sugges ha shareholder wealh declines in response o he announcemen of a small-bonus issue proposal; Chinese shareholders appear o view he announcemen of small-bonus proposals as bad news. In conras o he small-bonus socks, he large-bonus socks have posiive and significan CARs a he alernaive even dae 1 and for he inervals of daes 5 o 1, 10 o 1, and 20 o 1 before he announcemen dae, bu he CARs are insignifican afer he announcemen dae. Despie some shareholders anicipaing he informaion or obaining inside informaion before he announcemens, he sock prices sill reac o he large-bonus proposal announcemens significanly a he 1% significance level. The informaion conained in he large-bonus proposals is fully incorporaed ino he sock prices by he even dae 0. So, if we ignore he possibiliy ha inside informaion is being used, we mus conclude ha he sock prices reflec he large-bonus proposals efficienly. 16 The case of middle-bonus socks is no as canonical as he cases of small-bonus and largebonus socks. I behaves mos like ha of large-bonus socks. A he even dae 0 and during inervals before he announcemen dae, he CARs are posiive and significan a he 1% and 5% levels. This illusraes a significan price reacion o he middle-bonus proposals a he announcemen dae and he possible anicipaion or use of inside informaion. Furhermore, he negaive -values in each inerval afer he announcemen dae are comparaively smaller in absolue value (jus one is below 1.96), suggesing ha here is a sligh overreacion. In oher words, he socks are overpriced wih respec o he middle-bonus proposals prior o and a he even dae and hen are correced hereafer. This resuls in he CARs moving in opposie direcions before and afer he announcemen dae. Neverheless, i is fair o conclude ha he sock prices are reasonably efficien in reflecing he informaion of middle-bonus proposals. All in all, during he inervals around he even dae, here has been a cumulaive significan and posiive impac of he announcemen on reurns, so Chinese-residen shareholders have experienced an increase in wealh. 16 According o Meulbroek (1992), his disincion beween insider rading and semi-srong form marke efficiency may no be as imporan as we make ou since her resuls show ha insider rading is associaed wih boh quick price movemens as well as price discovery. Her resuls sugges ha insider rading promoes he informaional efficiency of sock markes. 15

17 4. Tess on he Announcemen of Bonus Approvals for A-Shares Using he same crieria as was used previously in grouping bonus proposals, we consruc hree bonus approval porfolios: he small-bonus porfolio of 172 bonus approvals, he middlebonus porfolio of 89 bonus approvals, and he large-bonus porfolio of 94 bonus approvals. The oal of 355 bonus approvals includes he 196 cases analyzed above. We seek o undersand he effecs of he announcemen of bonus approvals on sock prices, and hen we delineae he disinc influences ha he bonus proposals and approvals have on hese prices. 4.1 A-Shares Reurn Behavior around he Announcemen of Bonus Approvals The resuls of he ess on he announcemen of bonus approvals are summarized in Table-2. Table-2, Panel (a) and Figure-2 repor he CARs around he announcemen of bonus approvals for each porfolio. Firsly, he large-bonus approved socks perform beer han he small-bonus approved socks, which is consisen wih he analysis of large-bonus proposals on sock prices. This indicaes ha he Chinese-residen invesors are more favorably inclined owards he announcemen of large-bonus proposals and approvals han small-bonus proposals and approvals. Nex, here are peaks of CARs a he alernaive even dae +2 of each porfolio; his indicaes a delayed overreacion o he announcemen of bonus approvals. These peaks are no eviden in he CARs for he proposals. Comparing Table-2, Panel (a) wih Table-1, Panel (a), and Figure-2 wih Figure-1, we find ha he CARs relaed o he small-bonus approvals are above hose relaing o he small-bonus proposals, whereas, he CARs relaed o he middle-bonus and large-bonus approvals are below hose relaing o he middle-bonus and large-bonus proposals. The narrow range of CARs beween porfolios of bonus approvals and he smaller -saisics show ha he influence of bonus approvals is weaker han ha of bonus proposals. I appears ha he main informaional conen of bonus approvals has already been disclosed in he announcemen of he bonus proposals, bu here is some valuable informaion in he approvals hemselves This finding is consisen wih he sudies of cash dividend proposals and approvals. 16

18 Table-2. Resuls of he Tess on he Announcemen of Bonus Approvals for A-Shares in China's Sock Marke (a). Cumulaive Abnormal Reurns (CARs) Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Noes: 1. Small: he sample of 172 approvals wih bonus raios less han or equal o 2 for Middle: he sample of 89 approvals wih bonus raios larger han 2 for 10, bu less han or equal o 4 for Large: he sample of 94 approvals wih bonus raios larger han 4 for Overall: he sample of all 355 bonus approvals. 5. Dae 0: he dae of he announcemen. 6. Dae -1 o -20: he daes before he announcemen. 7. Dae +1 o +20: he daes afer he announcemen. 17

19 (b). Parameric and Nonparameric -es Saisics on he Abnormal Reurns for he Specific Even Dae Parameric -es Saisics Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Nonparameric (rank) -es Saisics Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall Noes: 1. Dae 0: even dae, he dae of he announcemen. 2. Dae -1: alernaive even dae, he announcemen may occur one day in advance of ha on record. 3. Dae +1: alernaive even dae, he announcemen may occur one day laer han ha on record. 4. If he -es saisic is larger in absolue value han 1.96 or 2.58, he relevan abnormal reurn is saisically nonzero a he 5% or 1% significance level, respecively. (c). Parameric -es Saisics on he Cumulaive Abnormal Reurns (CARs) in Inervals around he Even Dae Marke-Adjused Model Marke Model Dae Small Middle Large Overall Small Middle Large Overall 11 Days Around Even Day -5 o o o Days Around Even Day -10 o o o Days Around Even Day -20 o o o Noe: If he -es saisic is larger in absolue value han 1.96 or 2.58, he relevan CARs of he inervals are saisically nonzero a he 5% or 1% significance level, respecively. 18

20 Figure-2. Cumulaive Abnormal Reurns (CARs) for Bonus Approvals of A-Shares in China's Sock Marke (1). Marke-Adjused Model Cumulaive Abnormal Reurns (CARs) CAR Small Middle Large Overall Dae (2). Marke Model Cumulaive Abnormal Reurns (CARs) CAR Small Middle Large Overall Dae The -values of he parameric and nonparameric ess on he even daes in Table-2, Panel (b) are all posiive and large. In paricular, he -values ha occurred a he even dae 0 across every porfolio are dramaically larger han Meanwhile, he majoriy of -values a he 19

21 alernaive even daes 1 and +1 are sill above or The announcemen of bonus approvals generaes significanly posiive reurns a he even daes. Table-2, Panel (c) repors -ess on he CARs in inervals around he announcemen of bonus approvals. The -values for he inerval of daes 20 o 1 before he even dae for he small-bonus porfolio are below 1.96, which suggess ha invesors are pessimisic in heir anicipaion of he small-bonus approvals. For hese porfolios, he -saisics on he CARs afer he even dae(s) end o be negaive and insignifican; no correcion is made. The -values for he inervals of +1 o +5 and +1 o +10 afer he even dae for he middlebonus porfolios are below 1.95 or 2.58, which indicaes ha invesmen in hese socks incurs significanly negaive reurns afer he announcemen dae of he approvals. This evidence suggess ha he opimisic anicipaion of he middle-bonus approvals is reversed afer he announcemen of such approvals. For he large-bonus porfolio, he -values for each inerval before he even dae are above or +1.96, bu for he hree inervals afer he even dae hey are negaive and insignifican in five of six cases. No unwinding or correcion of he opimisic anicipaion of he even by Chinese raders ranspires for hese porfolios. 4.2 Assessmen of Marke Efficiency for A-Shares on he Announcemen of Bonus Approvals Sock prices reflec he announcemen of bonus approvals in a saisically significan and posiive manner a he even dae(s). However, his canno be simply labeled an efficien phenomenon. Firsly, he small-bonus approval should no be good news and should no engender he reacion of a large posiive reurn, unless shareholders hough ha he proposal announcemen was a signal of a weaker posiion han he firm acually had. The significan posiive reurns a he even dae, accompanied wih significan negaive reurns in he inervals before he even dae, show ha he marke correcs he negaive anicipaion of hese approvals when hey do finally occur. Since he negaive reurns are saisically insignifican afer he announcemen dae, we place he reacion of A-share prices o he announcemen of small-bonus approvals in he efficien caegory. Of course, since he CARs are significanly negaive for he enire 20 o +20 period, we conclude ha announcemens of small-bonus approvals, like announcemens of small-bonus proposals, lead o a decline in shareholder wealh. The CAR for 20

22 +20 is for he approval, while i was for he proposal, indicaing ha he informaion inheren in he proposal had a larger cumulaive impac han ha of he proposal for small-bonus issues. Similarly, he abnormal reurns for he large-bonus socks afer he announcemen dae, while negaive and hence suggesive of poenial overreacion, are also generally insignifican a he 5% level. The marke for large-bonus socks could be deemed semi-srong form efficien, or a wors ambiguous. Since he -saisics for he CARs for large-bonus socks over he inervals around he even dae ( 20 o +20 ec.) are posiive and significan (in five of six cases), we conclude ha he approval of large-bonus issues did have some informaional conen for Chinese-residen raders over and above he proposal. Furhermore, hese approvals had a posiive impac on shareholder wealh. In conras, he unusually large and posiive -values a he even dae and negaive -values for he inervals afer he even dae show ha he middle-bonus socks have a severe overreacion a he even dae. As a consequence, we conclude ha he reacion of A-share prices o he middle-bonus approvals is inefficien. I could be he case ha he middle porfolio is simply an average of he effecs aribued o he small-bonus and large-bonus issue approvals, and hence his overreacion is an arifac of our classificaion. The -saisics on he CARs for he inervals around he even dae ( 20 o +20 ec.) end o be insignifican. Again, his suggess ha he approval did no have any more informaional conen han he proposal and did no impac shareholder wealh. 5. Tess on he Announcemen of Bonus Approvals for B-Shares The records of bonus proposals of B-shares are of an insufficien number for saisical analysis. Thus, even sudy ess are only conduced on he 56 bonus approvals of B-shares. Among he 56 bonus approvals of B-shares, 34 of hem fall ino he small-bonus porfolio and 22 fall ino he middle/large-bonus porfolio wih a bonus raio larger han 2 for 10. Table-3 summarizes he resuls of he ess on he announcemen of bonus approvals of B- shares. Table-3, Panel (a) and Figure-3, Panels (1) and (2) illusrae he CARs as measured by he marke-adjused and he marke models. From ha able and hose figures i is eviden ha he B-share invesors have a similar assessmen o ha of he A-share invesors on he 21

23 informaion of bonus approvals. They prefer invesing in he middle/large-bonus socks o invesing in he small- bonus socks. The CARs of middle/large-bonus B-shares are mainly posiive and above he zero reurn axis, while he CARs of small-bonus B-shares are negaive and below he zero reurn axis. This evidence lends more suppor o he argumen ha largersized bonus issues signal ha managemen is very confiden abou he company s fuure performance. A comparison of Figure-3, Figure-2, and Figure-1 reveals ha he difference in he CAR lines beween he small-bonus and middle/large-bonus socks for he B-share bonus approvals is more similar o he difference beween he small-bonus and large-bonus socks for he A-share bonus approvals han for he A-share proposals. Therefore, while we did no es he bonus proposals for he B-shares due o he small porfolio size, we may hypohesize ha he B-share invesors may respond o he announcemen of bonus approvals more weakly han hey respond o he announcemen of bonus proposals. However, he CAR lines of he B-shares in Figure-3 are more volaile due o he small porfolio or sample size problem. Table-3, Panel (b) shows ha all parameric and nonparameric -values esed on he announcemen of small-bonus approvals for B-shares are less han in absolue value, indicaing ha he small-bonus B-share prices have no been significanly affeced by he announcemen a he even dae. This is in direc conras o he significan and posiive response of he A-share marke o he announcemen of small-bonus approvals. Apparenly, he wo differen ypes of raders, Chinese residens (A-share raders) and foreign residens (B-share raders), view he announcemen of small-bonus approvals differenly, wih Chinese residens viewing he informaion as a negaive signal. On he oher hand, he -values a he even dae 0 for he middle/large-bonus B-shares are larger han This implies ha he middle/large-bonus B-shares reac significanly and posiively o he announcemen a he even dae a he 5% significance level, a similar response o ha of he A-share marke. Thus, here appears o be some agreemen beween hese groups of raders regarding he informaional conen of larger-sized bonus issues. 22

24 Table-3. Resuls of he Tess on he Announcemen of Bonus Approvals for B-Shares in China's Sock Marke (a) Cumulaive Abnormal Reurns (CARs) Marke-Adjused Model Marke Model Dae Small Middle/Large Overall Small Middle/Large Overall Noes: 1. Small: he sample of 34 approvals wih bonus raios less han or equal o 2 for Middle/large: he sample of 22 approvals wih bonus raios larger han 2 for Overall: he sample of all 66 bonus approvals, including he small and middle/large samples. 4. Dae 0: he dae of he announcemen. 5. Dae -1 o -20: he daes before he announcemen. 6. Dae +1 o +20: he daes afer he announcemen. 23

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