The Effect of the Split Share Structure Reform on Working Capital Management of Chinese Companies. Abstract

Transcription

1 The Effect of the Split Share Structure Reform on Working Capital Management of Chinese Companies Abstract The purpose of the Split Share Structure Reforms (SSSR) in April 2005 was to align the interests of the state and private owners via conversion of state-owned non-tradable shares into tradable shares in most Chinese listed firms. Besides linking states wealth to stock returns, the SSSR also helped align interest of the management with minority shareholders by linking executive compensation to the firm s market performance. We hypothesize that these changes would manifest themselves in more efficient working capital management (WCM) decisions by the Chinese listed firms. Using 511 Chinese manufacturing firms that existed in 2003 in the CSMAR database and following these firms through 2011, we test this hypothesis and find that firms WCM policies significantly improve between the pre- and post-reform periods. We also note that the greater efficiency in WCM is associated with better post-reform performances of these firms. Keywords: Split Share Structure Reform, working capital management, cash conversion cycle, China JEL classification: G30, G38

2 The Effect of the Split Share Structure Reform on Working Capital Management of Chinese Companies 1. INTRODUCTION Prior to the Split Share Structure Reform (SSSR) of 2005, the Chinese listed companies were characterized by dual classes of shares - majority non-tradable shares owned by states and minority tradable shares held by private owners. State-owned shares, although non-tradable, enjoyed the same voting, cash flow, and other legal rights as their private counterparts. The dual structure allowed state owners control of the listed firms without being subject to market discipline. Consequently, the wealth of state shareholders were unaffected by the price movements of tradable shares, resulting in agency conflicts between the government who emphasized its own socio-economic agenda and private owners who stressed wealth maximization. 1 Company managers who were appointed by the government were unlikely to look after the best interests of private shareholders. Adding to the conflict was the regulatory environment that provided limited disclosure, poor investor protection, and over-reliance on the banking system. These factors led to suboptimal performance of tradable shares as found in Ang and Ma, 1999, Qi et al. (2000), Sun and Tong (2003), Green and Ho (2004), Kato and Long (2005), Qi et al. (2000) and Sun and Tong (2003) who conclude that state equity ownership has a negative impact on firm performance. Over time, the Chinese government realized the problems associated with the split-share structure. After several failed attempts, the China Securities Regulatory Commission (CSRC) launched the SSSR in April This reform eliminated the dualistic structured stock market 1 Socio-economic goals may include accepting a project with negative NPV for the specific purpose of job creation and sacrificing competition by insulating domestic firms from multinational competition.

3 by gradually converting non-tradable shares into tradable shares, thereby making state shareholders wealth sensitive to share price movements. 2 Has the alignment of interests between state and private shareholders had the intended wealth effect on minority shareholders? Several researchers (e.g., Jiang et al., 2008, Tseng, 2012, Yu 2013, and Bin et al., 2015) have examined the role of the SSSR in the wealth creation of Chinese listed firms and conclude that the reform has had positive impact on these firms performance. The improved performance in the post-reform years has been attributed principally to factors, such as decrease in agency problems (Tseng, 2012), reduction in multiple-principal problems through its reduction of state ownership (Jiang et al., 2008), and improved corporate governance (Yu 2013). 3 We posit that the performance improvement represents the cumulative effect of more efficient financial decisions by firms in the post-reform period. 4 In this paper, we examine whether the working capital management (WCM) decisions of Chinese listed firms became more efficient subsequent to the SSSR. In so doing, we investigate whether WCM of the Chinese listed firms has improved pursuant to the SSSR and if so, the extent to which the improved WCM is related to reduction in state ownership. We also examine the association between the WCM and the firm performance. We hypothesize that the SSSR leads to improved WCM decisions. We believe that SSSR is linked to the WCM through two pieces of reforms in particular: 1) the reduced dual ownership problem via dwindling ownership of non-tradable shares by states; and 2) increased management 2 State ownership remained high in strategically important industry sectors such as the oil, natural gas and mining sector and the publishing, broadcasting, and media sector (Yu, 2013). 3 However, Bin et al. (2015) disagree and suggest that although the SSSR improves the profitability performance, it does not necessarily benefit the corporate governance of Chinese listed companies. 4 Hou et. al. (2003) suggest that, consequent to the SSSR, both the state and private shareholders benefit when firms financial decisions increase market value.

4 holding resulting from enhanced compensation package that includes tradable shares to encourage executives to make efficient decisions (Hou et al., 2013). A common measure of a firm s WCM is its cash conversion cycle (CCC) - the number of days expiring between cash disbursements (to suppliers of raw materials) and cash recovery (from sales of the final product). Efficient working capital management often amounts to reducing CCC (in order to reduce opportunity costs of cash holdings) without negatively affecting a firm s profitability. Because of its very nature, the manufacturing industry is more directly concerned with the CCC. We, therefore, select all manufacturing firms that had existed in 2003, when such data became first available in the CSMAR database and, to isolate the true impact of the SSSR, follow the WCM policies of the same firms through We define as the pre-sssr period and 2006 through 2011 as the post-sssr period and compare WCM policies of these firms between the two periods. We measure the efficiency of the WCM by the CCC. We decompose the CCC in its three essential components and assess the impact of the SSSR on each of these components. The components are 1) days sales outstanding (DSO), (2) days inventory outstanding (DIO), and (3) days payable outstanding (DPO). We examine the impact of reduced government ownership of non-tradable shares as well as increased managerial ownership of tradable shares on the CCC and its three components. Hill, Kelly, and Highfield (2010), among others, have identified several factors that influence a firm s WCM decision: to ascertain that the effects of the two SSSR-induced variables prevail even in the presence of these factors, we add them as independent variables. By employing both univariate and multivariate techniques, we find that the efficiency of WCM increases with decreasing non-tradable state ownership. We conclude that the SSSR

5 provided an impetus for improving Chinese firms WCM. Further, consistent with Shin and Soenen (1998) and Deloof (2003), we find that decreased CCC is associated with better accounting and market performance of these firms. We conclude that the SSSR has succeeded in reducing the conflict of interests that obtained in the pre-sssr period. Our study contributes to the literature by providing new evidence indicating a link between the SSSR and improved operating efficiency as reflected in the WCM decisions. The remainder of the paper is organized as follows. In the first section we discuss our sample, variables, and methodology. Next, we discuss the empirical results followed by a summary and conclusions. 2. SAMPLE, VARIABLES, AND METHODOLOGY 2.1. Sample We obtain our sample from the China Stock Market & Accounting Research (CSMAR) Financial Statements and Trading databases (part of WRDS now). The ownership data is obtained from CSMAR Shareholder database and Corporate Governance database. We focus on the manufacturing industry because it is the largest industry in China and is characterized by a conventional flow of receivables and inventory. Our sample consists of all 511 manufacturing firms that existed in 2003 in the CSMAR database. Although the number of manufacturing firms contained in CSMAR increased substantially during the post-sssr years, we restrict our sample to the same 511 firms (4,599 firm-year observations) for the entire period of Restricting the sample would help us isolate the impact of SSSR by comparing the WCM policies of these firms before and after the reform.

6 2.2. WCM Measures A common measure of WCM in literature is CCC 5. Funds tied up in the CCC have opportunity costs: the longer the CCC, the higher is the opportunity cost. To meet working capital needs, managers sometimes seek short-term solutions such as attracting additional investments by owners, stretching payments to suppliers, restructuring debt to pay short-term liabilities with long-term debt, etcetera. These are only temporary measures because if a high CCC persists, the rising cash outflow from the gap might lead to insolvency or even bankruptcy: a persistently high CCC could lead to cash shortages even for a highly profitable company. A good WCM policy entails striking a balance between the costs (opportunity) and benefits (e.g., sales growth) associated with the length of the CCC which is often expressed in a expanded form as CCC = [DSO + DIO DPO] in which DSO (days sales outstanding) = (net accounts receivables x 365)/Net sales; DIO (days inventory outstanding) is (inventory x 365)/costs of goods sold; and DPO (days payables outstanding) is (accounts payables x 365)/cost of goods sold. Since the CCC is a flow concept of liquidity, changing any one of the three components can alter this measure. For example, decreasing the average collection period may result from tightening a company s credit policies, which, in turn, may reduce sales. A lower DIO might signal more efficient inventory management. On the other hand, a very low DSO might indicate understocking and lost orders, a decrease in prices, or a shortage of materials. Delaying 5 CCC has been the most common measure of a firm s WCM policy in the working capital literature (see, Hill, Kelly, and Highfield, 2010, for example).

7 payments of payables (i.e., extending DPO) might lower the CCC, but might also lead to foregoing of trade credit discount and damaging of goodwill with suppliers. Theoretically, an optimal level of CCC obtains where costs associated with the length equal its benefit. In practice, however, finding the optimal length presents a big challenge to managers Independent Variables SSSR-impacted Ownership Variables As said before, two SSSR-induced variables that we use are (1) state ownership of nontradable shares, (2) increases in managerial ownership of tradable shares Government ownership (STATE) In the pre-reform period, the ownership was concentrated in the hands of government holders. As the literature indicates, concentrated ownerships might be a double-edged sword. On the positive effects of concentrated ownership, Shleifer and Vishny (1986), Barontini and Caprio (2005), and Villalonga and Amit (2006), among others, conclude that having a large minority shareholder solves the problem of monitoring incentive in a corporation with many small shareholders. On the negative side, Ward, 1988, Kahn and Henderson, 1992, Mishra and McConaughy 1999, Morck, Stangeland and Yeung, 2000, Dyer, 2003, and Morck and Yeung (2003), among others, argue that concentrated ownership accentuates the agency problems between large and small shareholders, adversely affecting the firm performance. In the context of China, the agency problem was compounded by the fact that states held majority shares in most Chinese-listed firms and these shares were non-tradable: in the absence of the umbilical cord that ties the shareholders to the stock market, the states had limited interests in maximizing the price of a firm s shares. Exacerbating the problems were managers who were handpicked by the states. Consequently, neither states nor managers incentives were aligned

8 with minority shareholders, resulting in poor market performances of these firms, as reported in prior studies (e.g., Wei, Varela, D'Souza, and Hassan, 2003; and Wei, Xie, and Zhang, 2005). We posit that the absence of linkage between majority ownership and the stock market will find expression in inefficient financial decisions by Chinese-listed firms. We expect the state ownership to lead to inefficient WCM policies (i.e., the higher the state ownership the higher the CCC) during the pre-reform period. Subsequent to the reform, non-tradable shares were converted to tradable shares. Unfortunately, information regarding state ownership of tradable shares in the post-reform period is not available in CSMAR, forcing us to use state holdings of non-tradable shares (STATE) in both periods---before and after reform. Consequently, we hypothesize that the negative impact of state holdings (of non-tradable shares) would decrease significantly in the post-reform period Managerial holdings (MANG) In the pre-reform period, the government appointed managers based primarily, if not exclusively, on party loyalty. Two potential results of the SSSR involving managers are as follows: the state s role in appointing managers decreases, and managerial holding of tradable shares increases due primarily to new compensation packages that include stocks and stock options. 6 Consequently, managers are likely to be aligned with external shareholders more in the post-reform than in the pre-reform years, with the implication being that managers would make more efficient financial decisions (including WCM decisions) in the post-reform period. We measure managers holding by the percentage of total shares held by managers (MANG) and hypothesize that MANG will have a more positive impact on the WCM (i.e. a negative relation to CCC) in the post-reform period than in the pre-reform period. 6 Hou et al. (2013) show that managers remuneration package in the post-reform period has made them more responsive to stock returns via more efficient financial decisions.

9 Tradable shares as % of total shares (TSPT) The most important objective of the SSSR was to convert non-tradable shares to tradable shares. We employ tradable shares as a percentage of total shares before and after reform (TSPT) as an alternative to STATE and MGMT. To counteract the agency problems of non-tradable shares, the tradable shares had to play a more aggressive role toward decreasing CCC in the prereform period. In the face of the declining negative effect of dwindling percentage of nontradable shares after SSSR, we hypothesize, that TSPT will play a less aggressive role in the post-reform period Control Variables The pertinent literature identifies other factors that might impact a firm s WCM policies. To ascertain that the effects of the SSSR-induced changes persist even in the presence of these factors, we choose control variables following Hill, Kelly, and Highfield (HKH) (2010). As in Hill et al., we separate relevant factors in two groups: (1) a firm s ability to finance its operating working capital and (2) its operating conditions. Operating cash flows (OCF), capital market access (SIZE), market power (MKTSHR), and debt constraint (DR) comprise the first group, while sales growth (GROWTH) and sales volatility (SALVOL) are in the second group. In addition, we use institutional ownerships (INST) as the last control variable Operating cash flows (OCF) Greater operating cash flows (OCF) give a firm more flexibility in managing its working capital and allow it to pursue a more conservative policy. For example, higher OCFs enable a firm to carry a higher CCC. On the other hand, firms with low, especially negative, cash flows, have to finance their working capital needs externally and, therefore, might resort to an

10 aggressive WCM policy in order to reduce the need for external financing. We define OCF as lagged earnings before interest and taxes (EBIT) scaled by net assets and propose to determine the sign empirically Capital market access (SIZE) According to Hill et al. (2010), larger firms are more capable of financing the working capital gap externally and having relaxed credit and inventory policies due to superior access to capital markets. By contrast, smaller firms are less able to issue commercial paper or negotiate lines of credit. Following Hill et al., we define size (SIZE) as the natural logarithm of the lagged annual inflation-adjusted market value of equity and predict a positive relation between SIZE and the CCC Market power (MKTSHR) Hill et al. (2010) maintain that superior market power enables a firm to receive more generous credit terms from suppliers, offer shorter terms to customers, and gain better terms with vendors resulting in less investment in inventory. Thus, higher market power allows a firm to shorten its CCC by curtailing DSO and DIO and lengthening DPO, when necessary. Following Hill et al., we measure market share (MKTSHR) as the lagged ratio of a firm s annual sales to the total annual sum of sales in a given industry and expect a negative relation between MKTSHR and the CCC Debt constraint (DR) Higher leverage exposes the firm to a greater potential of financial distress and makes external financing more expensive. Consequently, if a firm has a limited ability to issue external financing, it is more likely to pursue an aggressive WCM policy (Hill et. al. 2010). We measure

11 leverage by the DR (debt ratio), which is a firm s lagged total debt-to-total assets relative to its peer group. We expect a negative relation between DR and the CCC Sales Growth (GROWTH) Hill et al. (2010) find evidence that prior period growth leads to a tightening of credit policy upon achieving the planned sales growth. Following Hill et al., we define growth (GROWTH) as the percentage change in sales in the current year from the previous year and predict a negative relation between GROWTH and the CCC. The same relation might be justified based on a firm s ability to raise external funding. According to Myers (1997), the growth option raises the cost of debt. Facing higher costs of external financing, the firm could be forced to pursue an aggressive policy toward WCM Sales Volatility (SALEVOL) Sales volatility might have implications for a firm s WCM policy, especially regarding its decision about how much inventory it should hold. However, the direction of the impact has to be empirically determined. Similar to Hill et al. (2010), we measure sales volatility (SALEVOL) as the standard deviation of a firm s annual net sales over a rolling five-year period before each sample year. Upon examining the available empirical evidence, Hill et al. (p. 786) conclude that the link between the net investment in operating working capital and sales volatility is an empirical question. Therefore, we refrain from predicting the sign of SALEVOL in relation to the WCM variables Institutional Ownership (INST) The pertinent literature is almost unanimous about the positive role that institutional holders play in disciplining managers to improve a firm s performance. Institutional holding 7 The debt ratio (DR) could also serve as a corporate governance variable based on the control hypothesis of debt proposed by Jensen (1986). This hypothesis also suggests a negative relation between the CCC and the DR.

12 (INST) is the percentage of shares owned by institutions. We expect a negative relation between INST and CCC, DSO, and DIO. Table 1 provides the summary of definitions of all variables. TABLE 1 GOES HERE Equation 2 shows the final regression model: CCC = f [STATE, MANG] + [OCF, SIZE, MKTSHR, DR, GROWTH, SALEVOL, INST] + ε 3. RESULTS 3.1. Summary Statistics Table 2 compares averages of all employed variables between the pre-reform ( ) and post-reform ( ) periods. The CCC, DSO, and DIO decrease while DPO increases significantly at the 0.01 level in the second period, pointing to improved liquidity and WCM policy. The CCC decreases by days between the two periods, which is primarily accounted for by a reduction of days in the DSO followed by days in the DIO. The increase in the DPO although by 3.22 days is significant at the 5% level. These results are consistent with the SSSR-induced changes in STATE and MANG: STATE ownership of nontradable shares decreases from 29.06% to 9.75%, while the ownership by MANG increases from 2.73% to 3.15% (both significant at the at the 1% level) between the two periods. The average number of tradable shares as a percentage of total shares (TSPT) increased from 41.15% to 86.16% between the pre- and post-reform periods. In terms of control variables, Institutional ownership (INST) increases from 20.19% to 32.42%. (at the 5% level) SIZE increases dramatically between the pre- and post-reform

13 periods. MKTSHR and OCF increase significantly at the 0.01 level while debt-to-asset ratio decreases at the 1% significant level. More efficient management of sales might help explain the reduced sales volatility (SALEVOL) in the post-reform period. A reduced growth in the postreform period is perhaps due to a much larger base of sales volume in the second period relative to the first Regression Analyses Table 3 presents regression results showing the effect of SSSR-induced variables (STATE and MANG) in presence of selected control variables on WCM decisions of Chinese listed firms over the two sub-periods---before ( ) and after ( ). Panel A and Panel B represent the pre-reform sub-period and post-reform sub-period respectively. Dependent variables are CCC (Column 1 and 2), DSO (Column 3 and 4), DIO (Column 5 and 6), and DPO (Column 7 and 8). The columns 1, 3, 5, and 7 use STATE and MANG to represent the SSSRinduced variables, while Columns 2, 4, 6, and 8 employ TSPT (Tradable Shares as a Percentage of Total Shares) replace STATE and MANG (and INST). All regressions consider the time and industry fixed effects. [TABLE 3 GOES HERE] SSSR-induced Variables , STATE As stated before, as CSMAR does not provide data on state holdings of tradable shares (after the reform-induced conversion), we define STATE as the state holdings of non-tradable shares. We hypothesize that the higher agency problems of STATE ownership of a very high percentage of non-tradable shares in the pre-reform period would have a negative impact on the

14 WCM efficiency (i.e., positive relation to CCC). However, the pre-reform negative impact should disappear in the post-reform period as state holdings of non-negotiable shares diminish substantially. Panel A results are consistent with this hypothesis: the STATE coefficients are positive and significant in relation to CCC and DSO and significantly negative when regressed against DPO, indicating inefficiencies in the WCM. The coefficient of STATE on DIO, however, is negative and significant (at the 10% level). This particular result is inconsistent with what we expected. The post-reform relations between STATE and WCM variables (Table 3, Panel B0 are also consistent with our hypothesis. In the post-reform sub-period, the STATE no longer has the negative impact on the WCM efficiency that it had in the pre-reform sub-period: its relations with CCC, DSO, and DIO are not significantly different from zero. Indeed, the relation between STATE and DPO is significantly positive which is completely opposite to the relation in prereform period. We find it difficult to explain this phenomenon MGMT We hypothesize that the increased ownership of tradable shares by management would improve the efficiency of the WCM. Perhaps because of the very low management holdings, we do not find MGMT to have no impact (positive or negative) on the WCM during either subperiod. The finding does not contradict the intended objective of the SSSR Tradable shares as a percentage of total number of shares ((TSPT) The objective of the SSSR was to increase the liquidity of the stock market via conversion of non-tradable shares into tradable shares. In keeping with this goal, TSPT increased significantly after the SSSR. To counteract the agency problems of non-tradable shares, the tradable shares had to play a more aggressive role toward decreasing CCC in the pre-reform

15 period. In the face of the declining negative effect of the dwindling percentage of non-tradable shares after SSSR, we hypothesize, that TSPT will play a less aggressive role in the post-reform period. Table 3 results support this hypothesis: all TSPT coefficients relative to CCC, DSO, DIO, and DPO are smaller in the post- than in the pre-reform period Control Variables Comment [T1]: WEI: this is where we can shine even more. If there is a simple way we can confirm this by comparing the coefficients before and after, please do it (at least for the CCC). If you can t do it now, we will have to do it before we submit this to a journal. Among control variables, INST, MKTSHR, DR, and GROWTH all have the expected negative sign (significant at the 1% level). We were uncertain about the sign of the OCF and concluded that it needed to be empirically determined. The results show that operating cash flow is negatively related (at the 1% significant level) to CCC Relation Between CCC and Firm Performance To examine if the improved WCM has contributed to the improved firm performances, we construct two tables. We measure performance in two ways---accounting performance measured by ROE and market performance measured by price-to-book (PB). PB is the market price per share divided by the book value per share. ROE is net income divided by common equity. Table 4 shows the impact of the industry-adjusted CCC on the industry-adjusted firm performance. The results show a negative relation between the industry-adjusted CCC and the industry-adjusted ROE and PB, implying that lower the industry-adjusted CCC the better is the firm performance. TABLE 4 GOES HERE

16 Table 5 investigates the relation between changes (from pre to post) in the CCC and the changes (from pre to post) in the firm performance as reflected in ROE and PB. The results are similar to what we observe in Table 4: negative changes in CCC are associated with positive changes in both ROE and PB. TABLE 4 GOES HERE 4. SUMMARY AND CONCLUSIONS The purpose of the Split Share Structure Reforms (SSSR) in April 2005 was to align the interests of the state and private owners via conversion of state-owned non-tradable shares into tradable shares in most Chinese listed firms. Besides linking states wealth to stock returns, the SSSR also helped align interest of the management with minority shareholders by linking executive compensation to the firm s market performance. In this paper we hypothesize the changes brought about by SSSR would manifest themselves in more efficient working capital management (WCM) decisions by Chinese listed firms. Using a sample of 511 Chinese manufacturing firms that existed in 2003 and following these firms through 2011, we test this hypothesis and find that firms WCM policies significantly improve between the pre- and post-reform periods. We also note that the greater efficiency in WCM is associated with better post-reform performances of these firms.

17 Table 1. Variables Definitions This table categorizes the variables in three groups: (1) dependent variables that measure a firm s WCM decisions, (2) governance variables, and (3) control variables that might affect WCM decisions. Column 4 shows the expected sign of the coefficients of the independent variables. Variable Name Computation Dependent variables CCC Cash conversion cycle Days sales outstanding + Days inventory outstanding Days payables outstanding DSO Days sales outstanding (Net accounts receivables x 365) / Net sales DIO Days inventory outstanding (Inventory x 365) / Costs of goods sold DPO Days payables outstanding (Net accounts payable x 365) / Costs of goods sold Governance variables Expected Sign Relative to CCC STATE Government ownership Percentage of state ownership relative to total shares outstanding + MANG Managerial ownership Percentage of executive ownership relative to total shares outstanding - TSPT Tradable share ownership Percentage of tradable share ownership relative to total shares outstanding - Control variables INST Institutional ownership Ownership of top 10 institutional shareholders - OCF Operating cash flow Lagged earnings before interest and taxes scaled by net assets - SIZE Firm size Natural logarithm of the lagged annual inflation-adjusted market value of equity - MKTSHR Market share of the firm Lagged ratio of a firm s annual sales to the total annual sum of sales in a given industry - GROWTH Growth rate of the firm Percentage of changes in sales from the previous year - SALEVOL Sales volatility The standard deviation of past 5-year sales scaled by net assets -/+ DR Debt ratio Debt to asset ratio - 17

18 Table 2. Descriptive Analysis of Chinese Listed Firms This table provides descriptive statistics about the ownership structure of Chinese listed companies. Pre-reform period measures are averages of and post-reform measures are averages of The fourth column shows the difference by subtracting the average values of each variable in from those in *, **, *** represent the level of significant at the 0.10, 0.05, and 0.01 levels, respectively. Pre-reform Period Post-reform Period Variables Mean Mean Difference Dependent variables CCC days days DSO days days DIO days days DPO days days 3.22 days** SSSR-induced variables STATE 29.06% 9.75% MANG 2.73% 3.15% 0.42%*** TSPT 41.15% 86.16% 45.01%*** Control variables INST 20.19% 32.42% 12.23%** OCF *** SIZE (log) *** GROWTH 28.81% 24.34% MKTSHR 0.13% 0. 14% 0. 01*** SALEVOL *** DR *** 18

19 Table 3. Regression Results This table presents regression results showing the effect of SSSR-induced variables (STATE and MANG) in presence of selected control variables on WCM decisions of Chinese listed firms over the two sub-periods---before ( ) and after ( ). Dependent variables are CCC (Column 1 and 2), DSO (Column 3 and 4), DIO (Column 5 and 6), and DPO (Column 7 and 8). The columns 1, 3, 5, and 7 use STATE and MANG to represent the SSSR-induced variables, while Columns 2, 4, 6, and 8 employ TSPT (Tradable Shares as a Percentage of Total Shares) replaces STATE and MANG (and INST). Definitions of all variables are provided in Table 1.. All regressions consider the time and industry fixed effects. The sample size is 511 firms. *, **, *** indicates the level of significance at the 0.10, 0.05, and 0.01 levels, respectively. Panel A: Pre-Reform Period CCC CCC DSO DSO DIO DIO DPO DPO Intercept *** *** *** *** *** *** *** *** <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 INST ** ** * ** TSPT * * * 2.494* STATE * 20.27** * * MANG OCF *** *** *** *** *** -1.1*** *** *** <.0001 <.0001 <.0001 < <.0001 <.0001 SIZE * * ** MKTSHR *** *** *** *** *** *** *** *** <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 GROWTH *** *** *** *** ** ** ** ** SALEVOL * DR *** *** ** ** *** *** * * <.0001 < R Industry dummies Year dummies Included Included Included Included Included Included Included Included Included Included Included Included Included Included Included Included 19

20 Panel B: Post-reform Period Intercept *** *** *** *** *** *** *** *** <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 INST -7.17* ** * -1.13* TSPT * * ** * STATE *** MANG OCF *** *** *** *** <.0001 < SIZE *** *** *** *** * -0.88* MKTSHR *** *** *** *** *** *** *** *** <.0001 < GROWTH ** ** ** ** SALEVOL *** *** *** *** *** *** *** *** <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 <.0001 DR *** *** *** *** * * 9.265* 9.478* R Industry dummies Year dummies Included Included Included Included Included Included Included Included Included Included Included Included Included Included Included Included 20

21 Table 4. The Impact of Working Capital Efficiency on Firm Performance This table presents the regression results depicting the relation between industry-adjusted CCC and industry-adjusted firm performance in the presence of selected control variables over the entire sample period to 2011). PB is the market price per share divided by the book value per share. ROE is net income divided by common equity. The sample size is 511 firms. Table 1 provides the definitions of the variables employed in this table. All equations consider the year and industry fixed effects. *, **, *** are levels of significance at 0.10, 0.05, and 0.01, respectively. Panel A Dependent Variable Industry adjusted PB Industry-adjusted ROE Intercept *** Industry-adjusted CCC Industry-adjusted SIZE 0.079*** Industry-adjusted GROWTH 0.659** 0.011* Industry-adjusted OCF 9.706*** 0.828*** Industry-adjusted DR *** Industry dummies Included Included Year dummies Included Included R F-statistic

22 Table 5. The Impact of Working Capital Efficiency on Firm Performance This table presents regression results depicting the relation between the changes in CCC and changes in firm performance in the presence of selected control variables. The sample size is 511 firms. It compares the changes in performance and changes in the CCC around the reform. PB is the market price per share divided by the book value per share. ROE is net income divided by common equity. Table 1 provides the definitions of the variables used here. The table reflects changes in the three-year average in the variables from pre-reform to post-reform. All equations consider the year and industry fixed effects. *, **, *** are levels of significance at 0.10, 0.05, and 0.01, respectively. Dependent Variable DPB DROE Intercept 0.988*** 0.018** DCCC 0.004*** 0.001*** DSIZE 0.141** DGROWTH 0.479** DOCF * DDR 1.001*** 0.021*** Industry dummies Included Included Year dummies Included Included R F-statistic

23 REFERENCES Comment [k2]: Yellow indicate new references. Ang, J. S., & Ma, Y. L. (1999). Transparency in Chinese stocks: A study of earnings forecasts by professional analysts. Pacific-Basin Finance Journal, 7 (2), Beltratti, A., & Bortolotti, B The Nontradable Share Reform in the Chinese Stock Market: The Role of Fundamentals. Available at 911/Beltratti%252C%2BBortolotti%2B- %2BThe%2BNontradable.pdf?MOD=AJPERES&ContentCache=NONE. Bin, L., Chen, D-H., & Chan, K-Y. (2015). Chinese corporate profitability performance following the split-share structure reform. Journal of Finance and Accountancy, 19 (March), Bortolotti, B., & Siniscalco, D. (2004). The challenges of privatization: An international analysis (pp ). Oxford: Oxford University Press. Chen, J. J. (2004). Determinants of capital structure of Chinese-listed companies. Journal of Business Research, 57 (12), Chen, G., Firth, M., & Rui, O. (2006). Have China's enterprise reforms led to improved efficiency and profitability for privatized SOEs? Emerging Markets Review, 7 (1), Claessens, S., Djankov, D., Lang, L. H. P., & Fan, J. P. H. (2002). Disentangling the incentive and entrenchment effects of large shareholdings. Journal of Finance, 57 (6), Deloof, M. (2003). Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30 (3 4), Deng, J., Gan, J., &. He, J The dark side of concentrated ownership in privatization: Evidence from China. Working Paper, Hong Kong University of Science and Technology. Fama, E., & Jensen, M. C. (1983). Separation of ownership and control. Journal of Law and Economcs, 26 (2),

24 Fabbri, D., & Klapper, L. F. (2009). Trade credit and the supply chain. Working Paper, University of Virginia and University of Amsterdam. Available at Frydman, R., Gray, C., Hessel, M., & Rapaczynski, A. (1999). When does privatization work? The impact of private ownership on corporate performance in the transition economies. Quarterly Journal of Economics, 114 (4), Green, S., & Ho, J. (2004). Old stocks new owners: Two cases of ownership change in China s stock market. Journal of Chinese Economic and Business, 2 (3), Gupta, N. (2005). Partial privatization and firm performance: Evidence from India. Journal of Finance, 60 (2), Hill, M. D., Kelly, G. W., & Highfield, M. J. (2010). Net operating working capital behavior: A first look. Financial Management. 39 (2), Hou, W., Lee, E., Stathopoulos, K, & Tong, Z. (2013). Executive compensation and the spilit share structure reform in China. European Journal of Finance, forthcoming. Available at Jensen, M. C. (1986). Agency costs of free cash flows, corporate finance, and takeovers. American Economic Review, 76 (2), Jiabalvo, J., Rajagopal, S., and Venkatachalam. (2002). Institutional Ownership and the Extent to which Stock Prices Reflect Future Earnings. Contemporary Accounting Research, 19 (1), Jiang, B-B., Laurenceson, J., & Tang, K. K. (2008). Share reform and the performance of China s listed companies. China Economic Review, 19 (3),

25 Kato, T., & Long, C. X. (2005). Executive compensation, firm performance, and corporate governance in China: Evidence from firms listed in the Shanghai and Shenzhen stock exchanges. William Davidson Institute Working Paper No. 690, [Online] Li, K., Wang, T., Cheung, Y-L., & Jiang, P Privatization and risk sharing: Evidence from the split share structure reform in China. Review of Financial Studies, 24 (7), Liao, L, Liu, B, & Wang, H. (2014). China s secondary privatization: Perspectives from the Split-Share Structure Reform, Journal of Financial Economics, 113 (3), McConnell, J. J., & Servaes, H. (1990). Additional evidence on equity ownership and corporate value. Journal of Financial Economics, 27 (2), Megginson, W. L., & Netter, J. M. (2001). From state to market: A survey of empirical studies on privatization. Journal of Economic Literature, 39 (2), Megginson, W. L., Nash, R. C., & Randenborgh, M. V. (1994). The financial and operating performance of newly privatized firms: An international empirical analysis, Journal of Finance, 49 (2), Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5 (2), Qi, D., Wu, W., & Zhang, H. (2000). Shareholding structure and corporate performance of partially privatized firms: Evidence from Chinese companies. Pacific-Basin Finance Journal, 8 (5), Shin, H-H., & Soenen, L. (1998). Efficiency of working capital management and corporate profitability. Financial Practice and Education, 8 (2),

26 Shleifer, A., & Vishny, R. W. (1986). Large shareholders and corporate control. Journal of Political Economy, 94 (3), Shleifer, A. (1998). State versus private ownership. Journal of Economic Perspectives, 12 (4), Smith, M. P. (1996). Shareholder activism by institutional investors: Evidence from CalPERS. Journal of Finance, 51(1), Sun, Q., and Tong, W.H.S. (2003). China share issue privatisation: The extent of its success Journal of Financial Economics, 70 (2), Sun, Q., Tong, W. H. S., & Tong, J. (2002). How does government ownership affect firm performance? Evidence from China's privatization experience. Journal of Business Finance and Accounting, 29 (1 2), Tseng, T. Y. (2012). Will China s split share structure reform mitigate agency problems? Journal of Chinese Economic and Business Studies, 10 (2), Wei, Z, & Varela, O. (2003). State equity ownership and firm market performance: evidence from China s newly privatized firms. Global Finance Journal, 14 (1), Wei, Z., Varela, O., D'Souza, J., & Hassan, M. K. (2003). The financial and operating performance of China's newly privatized firms. Financial Management, 32 (2), Wei, Z., Varela, O., & Hassan, M. K. (2002). Ownership and performance in Chinese manufacturing industry. Journal of Multinational Financial Management, 12 (1), Wei, Z., Xie, F., & Zhang, S. (2005). Ownership structure and firm value of China's privatized firms: Journal of Financial and Quantitative Analysis, 40 (1), Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of Financial Economics, 40 (2),

27 Yu, M. (2013). State ownership and firm performance: Empirical evidence from Chinese listed companies. China Journal Accounting Research, 6 (2),