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How corporate transparency influences stock returns

by CKGSB Knowledge

December 16, 2011

12-16On December 19, 1990, the Shanghai Stock Exchange (SSE) opened for business in Astor House Hotel. The first listed company was Yu Garden Restaurant, whose stock market price was around CNY300. Not long after that, the fourth Chinese Premier, Li Peng, and his wife paid a visit to the SSE to take a look themselves. This drove Yu Garden’s share price up to over CNY3700. When former Chinese president, Jiang Zemin, visited the Exchange, Yu Garden’s stock price rose further to more than CNY5000.

At that time, executives from the SSE and China Securities Regulatory Commission (CSRC) restated that stocks investment should not be publicized. If they were, then average Chinese citizens would be more likely to buy shares and the result would be that prices would fluctuate wildly. Without access to information, general investors consequently went to securities firms to ask for it or resigned themselves to relying upon analyses made by “securities analysts”. Some investors made great attempts to gain inside information through “guanxi,” or social connections.

As in China and developing countries that endure imperfect information disclosure, most stock prices tend to rise and fall with the market. In the past, economists have seen this as a clear demonstration that less transparency is what causes higher stock synchronicity. However, Gan Jie, finance professor at Cheung Kong Graduate School of Business (CKGSB), proposes, in opposition, that it is, in fact, an environment with more transparent information that actually leads to higher, rather than lower, stock return synchronicity.

“Stock prices are more affected by unknown information,” argues Gan. “Our point is that a more transparent information environment can lead to higher rather than lower stock return synchronicity because stock prices respond only to announcements not already anticipated by the market.”

Imperfect Information VS Lower Stock Return Synchronicity

In 1999, during the worst Chinese stock market bubble to date, stock market analysts showed little concern about basic information regarding listed companies. Instead, they concentrated on a methodological, broad picture of market trends. The resulting delay in disclosure of information about public companies led investors to overreact.

“In more transparent environments, stock prices should be more informative about future events. Consequently, when the events actually happen…there should be less ‘surprise’, i.e., there is less new information impounded into the stock price. Thus, a more informative stock price today means higher return synchronicity in the future,” said Gan.

Transparency VS Credibility

John Thain, former CEO of the New York Stock Exchange, said, in 2005, that in order to win back investors’ confidence, the New York Stock Exchange optimized its internal managerial mechanism and increased firm-specific information transparency so that investors could decided on the best timing to buy or sell stocks.

He also alleged that credibility was the basis for dealing in securities. Listed companies should do a better job with regard to supervision, auditing, transparency, and information disclosure so that investors can be clear about what the company is doing and will feel more confident in investing in these companies.

“When the information environment of a firm improves, and more firm-specific information is available, market participants are able to improve their predictions about the occurrence of future firm-specific events,” Gan said. “As a result, the surprise components of stock returns will be lower, when the events are actually disclosed, and return synchronicity will be higher.”

Firm-related Information VS Higher Stock Return Synchronicity

The year of 2009 marked a bumper harvest for Tsingtao Brewery Co., Ltd., although at the same time global financial crisis wreaked havoc on other companies. As the first Chinese company listed in both mainland China and Hong Kong, Tsingtao Brewery successfully acquired Jinan Spouting Spring Beer Company and exercised warrants. It raised finances of CNY 1.1 billion and profits increased by 70 to 80%.

Jin Zhiguo, CEO of Tsingtao Brewery, summarized, “Tsingtao Brewery has been obeying the rules of the capital market since the very beginning. We try to act with transparency and disclose true, accurate, and all-sided information about the company. Only with transparency can we consciously accept oversight from the public and operate as a well-organized company.”

Lenovo Group Limited, the leading Chinese multinational technology company, has been releasing a quarterly report to the public since 1998. “We believe quarterly report are an effective channel to help investors be more informed of our company’s decision-making, business philosophy, and the company’s value,” said Li Lan, of Lenovo. This approach helped instill confidence in general investors, contributing to Lenovo’s stock price momentum from 1998 to 1999 and unprecedented high in 2000.

For stocks buyers, a company’s ability to make profit is more than simple financial statements. According to Li, what is more important is how the company helps its investors understand the company’s status quo and its future.

As Gan reiterates, increased disclosure by public companies would lead to more variation in their stock prices, due to market-wide data, in the future. For investors, this is a welcome finding in volatile markets. For managers of public companies, it may lead to more pressure from investors for open disclosure and stable stock prices.

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