The Information Environment of China's A and B Shares: Can We Make Sense of the Numbers?

In 1990, three stock exchanges were opened in Shanghai, Shenzhen and Beijing. Partial privatization of China's enterprises began with offering two types of shares: A shares are sold only domestically to locals and are denominated in local currency; B shares are denominated in dollars and are sold only to foreign investors. All listed firms offer A shares, but to qualify for offering B shares, the firm must prepare financial statements in accordance with International Accounting Standards and also meet other requirements. Firms issuing A shares only adopt domestic accounting regulations. As a way of generating capital funds, market segmentation has been a success. Both types of shares, however, have two different information environments. The environment of A shares appears to be dominated by local regulations and customs at the time of offering or trading. The information environment of A shares appears to be relatively unstructured and is affected by informal communication between various groups. Other than the roles played by state officials and appointed managers, external monitoring of A shares appears to be limited. Independence and social acceptance of auditing appear to be making slow progress, especially when the majority of domestic CPA firms are government owned. In contrast, the information environment for the B shares is more structured because (1) financial reporting adheres to International Accounting Standards, (2) financial statements are audited by CPA firms with international practice; and (3) foreign investors - mainly large financial institutions - also act as external monitors. We elaborate on the differences between these two information environments and suggest that accounting earnings and A share prices are not correlated, but earnings and share prices are correlated for B shares. In an event-study approach, we find results inconsistent with both hypotheses - for 1994 and 1995 we find that earnings and unexpected returns are correlated for A shares but not for B shares. The high price volatility, the significant and continuing dominance of government officials, and the thinness of trade in B shares are offered as possible explanation for these results.