entities and most of these entities are ultimately owned by the state. One type of legal entity is an
SOE. An SOE typically floats off part of its activities into a listed firm but it retains a majority or
controlling stake in it. The listed entity is often the profitable operations of the SOE. Legal
entities are required to maximize the return on their investments. The shares held by the state and
legal entities are not tradable on the two stock exchanges.6 The state and legal entity
shareholders are typically blockholders and the largest blockholder often controls the firm as
they have substantially larger investment stakes than the second largest blockholder (there might
not even be a second blockholder) (Xu, 2004). On average, about 40% of a listed firm’s shares is
owned by private individuals and private institutions, and these shares (called A-shares) are
actively traded on the exchanges.7 About 10% of listed firms have also issued shares to
foreigners (called B-, H-, and N-shares). All the shares, tradable and non-tradable, rank paripassu
in terms of dividends and voting. In China, managerial and director stockholdings are very
small and executive stock option schemes are rare during the period we investigate. For this
reason we do not examine executive stock ownership in our analysis of corporate financial fraud.
The designation of shares into state, legal entity, and individual is enshrined in China’s
company law. Note that legal entities are ultimately owned by the state. However, legal entities
(such as SOEs) have somewhat different objectives than state stockholders. Legal entities are
usually charged with making profits, whereas for state stockholders profit may not be the sole
4 The SOE, itself, remains 100% owned by the central or regional government. The SOE has a number of social and
political objectives that go beyond the making of profits (Bai et al., 2000).
5 Bortolotti and Faccio (2004) show that many governments keep a controlling or dominant ownership stake in
privatized SOEs. Thus China is not the only country where dpartial privatizationsT occur. Bortolotti and Faccio also find
that high state ownership in privatized SOEs results in superior financial performance (measured by the market to book
ratio). Gupta (2005) finds that partial privatizations in India have a positive impact on a firm’s sales, profits, and labor
productivity. These findings stand in contrast to the results from China’s privatizations (Chen et al., 1998, in press-a),
where high state ownership was found to be detrimental to financial https://www.51lunwen.org/StudentPapers.htmlperformance.
6 The Shanghai Securities Exchange (SHSE) opened in December 1990 and the Shenzhen Stock Exchange (SZSE)
opened in July 1991.
7 Shares owned by individuals are very actively traded. The average holding period has been estimated to be as little as
2 months (Poon et al., 1998).
G. Chen et al. / Journal of Corporate Finance 12 (2006) 424–448 427
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