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					           The Impact of Market Segmentation on the Value-Relevance of

                   Accounting Information: Evidence from China




                                   Shwu-hsing Wu
                           Tainan University of Technology

                                     Stephen Lin*
                            Florida International University

                                     Shu-hsing Li
                              National Taiwan University

                                      Meihua Koo
                    California State Polytechnic University, Pomona

                                      May 2008




*Corresponding author Stephen Wen-jen Lin
11200 S.W. 8th Street
Ryder Business Building, RB 237B
Miami, Florida 33199-0001

Tel: (786) 210-3688 Email: lins@fiu.edu
            The Impact of Market Segmentation on the Value-Relevance of

                     Accounting Information: Evidence from China

Abstract

       This paper examines the extent to which the market segmentation policy in China

has affected the value-relevance of accounting information, measured by earnings and

book value of shareholders’ equity. Using Chinese data during the period of 1997-2005,

we find that the price difference between A- and B- shares significantly decreased after the

change in the market segmentation policy was announced in China in 2001. However, the

association between A-share price and accounting information significantly increased after

2002. Although the price-accounting association becomes much weaker for B-shares

during the transition period of 2000-2001, this association also significantly increased after

2002. Different from previous studies that examine how the quality of accounting

information affects share valuation, this study contributes to the literature by providing

further evidence on the roles of market condition and information environment in the

association between share price and accounting information in an emerging capital market

such as China.
     The Impact of Market Segmentation on the Value-Relevance of Accounting

                          Information: Evidence from China

1. Introduction


       This study examines the extent to which the market segmentation policy in China

has affected the association between share price and accounting information, measured by

earnings and book value of shareholders’ equity. We focus on the A- and B- shares

because they are the only two types of public shares traded in the Chinese stock markets.

Consistent with previous studies in the literature (e.g. Francis and Schipper, 1999; Core,

Guay, and Buskirk, 2003; Lin and Chen, 2005; Sami and Zhou, 2004), we measure the

value-relevance of accounting information as the explanatory power of earnings and book

value of shareholders’ equity for share price (i.e. the adjusted R-squared value of

regressing share price on earnings and book value of equity). Our study compares the

value-relevance of accounting information before and after the change in the market

segmentation policy in 2001 for both the A- and B- share markets.


       Both A- and B- shares carry the same dividends, voting, and liquidation rights but

were traded separately by domestic and foreign investors respectively and had substantial

differences in share prices and trading volumes before the market was fully segmented in

China. For example, the average share price (trading volume) of A-shares was more than

five (three) times higher than those of B-shares in 1999. Many studies find that the price

difference between the two-class shares is caused by the completely segmented markets

(e.g. Bailey, 1994; Fung, Lee, and Leung, 2000), relatively illiquid B- share market (Chen,

Lee, and Rui, 2001), and information asymmetry between the A- and B- share markets




                                            1
(Chui and Kwok, 1998; Chakravarty, Sarkar, and Wu, 1998; Yang, 2003). Some studies,

however, provide other reasons. For example, Chen, Lee, and Rui (2001) find that B-

shares tend to move more closely with market fundamentals than A-shares. Mei,

Scheinkman, and Xiong (2005) find that Chinese domestic investors mainly trade A-shares

based on speculation.


       For the first time in history, the Chinese government allowed domestic investors to

trade B-shares from February 19, 2001 to transform the market segmentation policy that

had been implemented in China for more than a decade. The initial market reactions to this

policy change were enormous. For example, the trading volumes of B-shares had doubled

and were even higher than those of A-shares during 2000-2001. In contrast, the mean and

median prices of A-shares dropped to be only two times higher than those of B-shares in

2001, while the mean and median prices of A-shares were more than five times higher than

those of B-shares in 1999. The mean and median price differences between the two-class

shares, however, dropped to around 55% and 70% respectively in 2004.


       Chinese listed companies follow two sets of accounting standards if they issue both

A- and B- shares. Chinese Accounting Standards (CAS) are used to prepare and audit

primary financial statements for the A-share market where shares are denominated in local

currency (Reminbi). International Financial Reporting Standards (IFRS) are used to

prepare and audit financial statements for the B-share market where shares are

denominated in US dollars on the Shanghai Stock Exchange (SHSE) or in Hong Kong

dollars on the Shenzhen Stock Exchange (SZSE). Moreover, financial statements are

audited by local and international accounting firms for the A- and B- share markets,




                                            2
respectively. In practice, Chinese companies issuing both classes of shares are allowed to

prepare their primary financial statements using CAS first and then reconcile the key

financial figures and ratios to those using IFRS. Finally financial statements for the A (B)

market are reported in Chinese (English).


       Many studies have investigated the value-relevance of accounting information in

China and provided very mixed results for the A- and B- share markets. Some studies (e.g.

Abdel-Ktalik, Wong, and Wu, 1999; Eccher and Healy, 2000; Hu, 2002; Lin and Chen,

2005) find that CAS accounting information is value-relevant and provides incremental

price information beyond IFRS accounting information. Other studies (e.g. Bao and Chow,

1999; Sami and Zhou, 2004), however, find that IFRS accounting information is value-

relevant and provides incremental price information beyond CAS accounting information.


       There are two potential reasons why previous studies fail to provide consistent

evidence as to whether CAS or IFRS can provide more useful information for share

valuation in the Chinese stock markets. First, previous studies may not provide comparable

results because they have used various samples and research designs (Sami and Zhou,

2004). Second, the information environment (Abdel-Khalik, Wong, and Wu, 1999) and

market conditions and efficiencies (Aboody, Hughes, and Liu, 2004) of the Chinese stock

markets have been largely ignored in previous research. Previous studies use data before

2001 and do not directly investigate the potential impacts of the market segmentation

policy on the conditions and efficiencies of the Chinese stock markets, which may have

significant implications for the value-relevance of accounting information.


       The change of the market segmentation policy in China provides a unique setting to



                                             3
investigate how the changes in price difference and trading volume between A- and B-

shares have affected the association between share price and accounting information.

Following previous studies, we investigate this issue by comparing the explanatory power

of earnings and book value of equity for share price in the A- and B- share markets in the

pre- and post- market segmentation periods. In doing so, this study integrates and

contributes to two strands of literature. They are (a) the value-relevance of accounting

information in the Chinese stock markets and (b) the effects of the market segmentation

policy on share valuation in China.


       Using Chinese data during the period of 1997-2005, we investigate and find that the

association between share price and accounting information, measured by earnings and

book value of equity, is much weaker for A-shares than B-shares when the Chinese stock

markets were fully segmented before 2001. The association between A-share price and

accounting information, however, increased after 2002. In contrast, the price-accounting

association significantly decreased for B-shares during the transition period of 2000-2001

when the share price and trading volume of B-shares reached their highest levels. The

price-accounting association for B-shares, however, significantly increased after 2002. The

above empirical results suggest that the market segmentation policy in the Chinese stock

markets has significantly affected the usefulness of accounting information for share

valuation in China.


       Different from most previous studies that examine how the quality of accounting

information affects share valuation, this study contributes to accounting literature by

providing empirical evidence on the role of market condition and information environment




                                            4
in the association between share price and accounting information in an emerging market

such as China.


       The rest of the paper is organized as follows. Section 2 discusses the market and

accounting reforms in China. Section 3 summarizes prior research and develops the

testable research hypotheses. Section 4 describes the sample selection criteria and data

collection. Research methods are discussed in Section 5. Section 6 reports empirical

results. Section 7 summarizes empirical results from the robustness tests. The final section

summarizes and concludes.


2. Market and Accounting Reforms in China


       Chinese stock markets are unique because of their various classes of shares and

types of ownership. Chinese companies have issued A-shares to raise capital from

domestic investors since 1990. International investors have been allowed to trade B-shares

in the Chinese stock markets since February 21, 1992. Domestic investors have been

permitted to trade B-shares since the market segmentation policy was modified on

February 19, 2001. The average price difference between A- and B- shares was

significantly reduced from five times in 1999 to approximately two times in 2001.


       Besides the change in the market segmentation policy in 2001, China has

harmonized its domestic accounting standards to be in line with IFRS since 1985. CAS has

been revised in 1992, 1998, and 2001, respectively, although significant differences in

accounting measurements still exist between IFRS and CAS. They include inventory, long-

term equity investments, revenues, leases, the valuation of fixed assets, amortization of




                                             5
intangible assets, methods of income tax accounting, measurement and amortization of

goodwill and intangible assets, and research and development costs etc. (Deloitte Touch

Tohmatsu, 2002). Generally speaking, CAS is a more cash- and tax- oriented accounting

system, whereas IFRS is a more fair value-oriented accounting system. Despite the

significant discrepancies between CAS and IFRS, the correlation coefficients between

CAS and IFRS earnings appear to be highly correlated. This may be because Chinese

managers attempt to manage their accounting numbers to avoid reporting large disparities

between the two accounting systems (Eccher and Healy, 2000). However, China has

improved the regulatory environment in recent years to increase the usefulness of

accounting information provided by Chinese companies, For example, the Chinese

government has changed regulations to increase accounting disclosure 1 , prevent inside

trading, and implement the best practices of corporate governance for listed firms since the

early 2000s. 2 (Wu, Koo, and Kao, 2007).


        Moreover, there have been changes in company ownership over the last few years.

Chinese listed companies normally have four different types of ownership. First, state

shares are those shares owned by central and local governments, which can only be

transferred to domestic institutions and are not allowed to trade on the stock exchanges.

Second, legal person shares are those shares owned by domestic institutions and foreign


  1 The CSRC requires listed firms’ management, assets, and finance and treasury functions to be
    independent from major shareholders. All listed firms must disclose party transactions and intangible
    asset information. In addition, all listed firms are required to post their annual reports on designated
    Web sites.

  2 If companies are prepared to issue 300,000 or more shares, they must conduct an additional audit in
    accordance with IFRS. The Chinese Supreme Court has also established procedures for investors to sue
    corporate directors and managers for missing or false information. The code requires independent
    directors on the board, shareholder rights, and related-party transactions be disclosed in an adequate
    and timely manner.



                                                     6
partners of joint ventures. They are non-tradable and virtually controlled by the

government. Third, employee shares are those shares offered to managers or employees by

Chinese listed companies; these shares can only be tradable after filing for permission with

the Chinese Securities Regulatory Committee (CSRC). Finally, tradable shares are those

tradable A-shares, B-shares, H-shares, and N-shares. Of these, H-shares are only issued

and traded at the Hong Kong Stock Exchange; N-shares are only listed and traded at the

NYSE. A breakdown of the ownership structure of Chinese listed companies during the

period of 1997-2005 is reported in the Panel D of Table 1.


         Although the CSRC allowed non-tradable shares to be gradually sold to the public

investors from June 2001, the CSRC had to stop this activity in June 2002 because both the

SHSE and SZSE Indices had significantly dropped due to the impact of the fall of internet

share prices. Average state ownership stood at about 70% by the end of 2002. On April 29,

2005, the CSRC announced the split-share structure reform plan to convert all non-tradable

shares to be publicly tradable, which has triggered a significant increase in the share price

and liquidity of both A-share and B-share markets, though the B-share market is not even

directly involved in the reform. In June 2006, 1006 A-share companies completed the

transformation and significantly improved the liquidity of Chinese stock markets (CFA,

2007).


         The market segmentation policy in China has been modified because, since

February 19, 2001, B-shares can be traded by both domestic and foreign investors.

However, the Chinese stock markets are somewhat ”segmented” due to the following three

factors. First, A-shares can only be traded by domestic investors. Second, the requirement




                                             7
that US or Hong Kong dollars be used to trade B-shares remains the same. Finally, the

trading volumes of B-shares are still much smaller than those of A-shares, although they

significantly increased after 1999.


3. Prior Research and Hypothesis Development


       Two strands of literature are related to this study. They are (a) the effects of the

market segmentation policy in China on share valuation, and (b) the value-relevance of

accounting information in the Chinese stock markets. We provide separate summaries of

previous findings in these two areas and develop two testable hypotheses in the following

sections.


3.1 Impacts of Market Segmentation on Share Valuation


       Bailey and Jagtiani (1994) and Domowitz, Glen, and Madhavan (1997) examine

how market segmentation induced by ownership restrictions affects stock price in

Thailand and Mexico, respectively. Both studies report substantial price premiums for

foreign shares (i.e. shares traded by foreign investors only) over domestic shares (shares

traded by domestic investors only). The empirical evidence for the Chinese stock markets,

however, indicates that foreign investors actually pay much less for B-shares than

domestic investors do for A-shares. As mentioned previously, the mean and median prices

of A-shares were over five times higher than those of B-shares in 1999.


       Many studies investigate the underlying reasons for the substantial price difference

between A- and B- shares. For example, Chakravarty, Sarkar, and Wu (1998) argue that

the discounts in B-share prices exist because foreign investors have difficulties in



                                            8
acquiring and assessing information about local Chinese companies due to language

barriers, different accounting standards, and lack of reliable information about the local

economy and companies. Chen, Lee, and Rui (2001), however, argue that the demand

elasticity for A- and B- shares could be different because the investment opportunities for

domestic investors are limited, while foreign investors can easily diversify their

investments in global capital markets. They find that the big discounts of B-share prices

are primarily caused by the illiquid B-share market. Under this relatively illiquid market,

the expected return is higher and share price is lower to compensate investors for

increased trading costs. Zhang and Zhao (2004) also argue that the substantial price

difference between A-share and B-share prices can be an indicator for the political risk in

Chinese stock markets perceived by foreign investors due to inadequate protection of

shareholders’ rights under such a transitional economy.


       Using Chinese data for the period of 1994-1996, Chakravarty, Sarkar, and Wu

(1998) provide evidence that domestic investors are more informed than foreign investors

because foreign investors rely more on financial reporting information, while Chinese

domestic investors have access to alternative local information sources in addition to

financial reporting information. Some studies (e.g. Chui and Kwok, 1998; Yang, 2003;

Froot and Ramadorai, 2007), however, document that foreign investors have a relative

information advantage because foreign investors are mainly institutional investors who are

more experienced and well equipped with advanced technology to analyze the accounting

information than Chinese domestic investors. Chan, Menkveld, and Yang (2007) find that

the signed trading volume and quote revision of the A-share market had strong predictive

ability for B-share quote returns, but not vice versa before February 19, 2001. In other



                                            9
words, domestic investors had a relative information advantage before the change in

Chinese market segmentation policy. However, they find reverse causality from the B-

share market to the A-share market after February 19, 2001, indicating that the information

transmission between the A- and B- share stock markets increased the information

advantage of foreign investors after the change in the market segmentation policy.


       Since Chinese domestic investors are now allowed to trade B-shares in the Chinese

stock markets, there are two important implications of this change. First, the liquidity of

the B-share stock market could be significantly improved because of an increase in the

demand of B-shares after this policy change. This may result in an increase in B-share

price. Second, part of the investment funds that were invested in the A-share stock market

might be shifted to invest in the B-share stock market simply because B-share price was

much lower than A-share price. This may result in an increase (a decrease) in B- (A-) share

prices. The above two factors may have jointly reduced the difference in price and trading

volume between A- and B- share stock markets.


       Furthermore, allowing Chinese domestic investors to trade B-shares may have

reduced the information asymmetry or improved the information environment in the

segmented Chinese stock markets, which could significantly reduce the price difference

between A- and B- shares and therefore increase the association between share price and

accounting information. We therefore predict that the change in the market segmentation

policy in China may have improved the association between share price and accounting

information in both the A-share and B-share stock markets. Hence, we develop the

following hypothesis (in alterative terms).




                                              10
       H1: The change in the market segmentation policy in China has increased the
       value-relevance of accounting information in both the A- and B- share markets.

       Many studies have also examined the value-relevance of accounting information,

measured by earnings and book value of equity, for both the A- and B- share markets, but

found rather mixed results. For example, using Chinese data for 1994 and 1995 Abdel-

Khalik et al. (1999) find a significant association between earnings and abnormal returns

for A-shares but not for B-shares. They argue that the high price volatility, dominance of

government officials, and illiquid B-share market may have contributed to the usefulness

of accounting information for B-share price. Using data during the period 1993-1997,

Eccher and Healy (2000) provide evidence that IFRS earnings do not provide incremental

price relevant information beyond CAS earnings for companies issuing B-shares.

However, CAS earnings can explain the variations of share returns better than IFRS

earnings for companies issuing A-shares. More interestingly, they find very high

correlation between IFRS and CAS earnings and argue that neither IFRS nor CAS were

effectively enforced in China.


       Using data during the period of 1991-1998, Chen, Chen, and Su (2001) provide

evidence indicating that Chinese domestic investors use CAS accounting information when

valuing A-shares despite some evidence of inadequate accounting and financial reporting

practices in China. Their finding suggests that the price model provides stronger evidence

than the return model. A similar study by Chen, Firth, and Kim (2002) finds that both IFRS

and CAS accounting information are useful in explaining the variations of A-share and B-

share prices. They argue that IFRS accounting information may be used by A-share

investors because there are no barriers for domestic investors to have access to the



                                           11
financial statements prepared for B-share investors. Chen et al. (2002) also document that

accounting information is more correlated with share price for companies with higher

individual and non-state ownership. Using more recent data (i.e. 1992-2000), Lin and Chen

(2005) re-examines the value-relevance of accounting information for companies

simultaneously issuing A- and B- shares. They find that CAS earnings and book value of

equity jointly can better explain the variations of A- and B-share prices than IFRS earnings

and book value of equity. They also find that the CAS earnings are associated with annual

share returns in both stock markets, although the association appears to be stronger in the

A-share market. Overall their study provides evidence indicating that CAS accounting

numbers are more value-relevant than IFRS accounting numbers in Chinese stock markets

at present.


       At least two studies provide evidence that IFRS accounting information provides

incremental price information beyond CAS accounting information. Using data during the

period of 1993-1996, Bao and Chow (1999) find that IFRS earnings and book value of

equity jointly can better explain the variation of B-share price than CAS earnings and book

value of equity. In addition, Sami and Zhou (2004) investigate the relative value-relevance

of accounting information prepared and audited by IFRS and CAS respectively, and find

that accounting information is reflected in the price process in both the A- and B-share

markets and that the accounting information in the B-share market is more value-relevant

(i.e. higher explanatory power of earnings and book value of equity for share price) than in

the A-share market. They also find that the value-relevance of accounting information in

the A-share market was very low in earlier years (i.e. 1994 and 1995) and decreased in

later examined years (i.e. 1999 and 2000). They do not further examine the reasons



                                            12
underlying their findings.


        In summary, the relative value-relevance of the accounting information prepared

and audited by IFRS and CAS appears to vary in previous studies. It is therefore predicted

that the change in the market segmentation policy in China may have different impacts on

the value-relevance between share price and accounting information in the A- and B- share

markets. The second hypothesis is developed as follows (in alternative form):

        H2: The change in the market segmentation policy in China has different
        impacts on the value-relevance of accounting information for both the A- and B-
        share markets

We examine the above research question by using the following data and research

methods.

4. Research Methods


        This study primarily uses the accounting-based valuation model suggested by

Ohlson (1995) for three reasons. First, this model considers both earnings and book value

of shareholders’ equity, which have been widely used in the literature to evaluate the

value-relevance of accounting information (e.g. Collin at al., 1997; Barth at al., 1998;

Francis and Schipper, 1999). Second, previous studies (e.g. Bao and Chow, 1999; Hu,

2002; Chen, Firth, and Kim, 2003; Lin and Chan, 2005; Sami and Zhou, 2004) have used

this model to investigate the value-relevance of accounting information in China 3 . We use



3 Brown, Lo, and Lys (1999) argue that the between-sample comparisons of R2 from regressions of share
  price on earnings and book value per share are invalid unless the difference in the scale factor’s
  coefficient of variation is controlled. This study is unable to investigate this issue due to limited
  observations in our sample (less than 10 years). Sami and Zhou (2005) show that their results using
  different scales (book value and number of outstanding shares) are qualitatively the same. To further


                                                   13
this model to compare our results with previous findings. Finally, Chen, Chen, and Su

(2001) find that the price model provides stronger results than the return model. We

therefore use the return model suggested by Easton and Harris (1991) for robustness

purposes. Under this model, annual share returns of A- and B- shares regress on the level

of and change in CAS and IFRS earnings. Details of these two models are described as

follows.


Model 1: Price Model


 PitA( B ) = α 0 +α 1Eit ( IFRS ) + α 2 BVitCAS ( IFRS ) + ε it
                      CAS




Where PitA( B ) is the share price per share for A- (B-) shares at the end of the fourth month

                                                     CAS
after the fiscal year-end for firm i for period t; Eit ( IFRS ) is earnings per share based on

CAS (IFRS) for firm i for period t; BVitCAS ( IFRS ) is the year-end book value of shareholders’

equity based on CAS (IFRS) for firm i for period t. We report results using cross-sectional

(i.e. yearly) and pooled regressions, and also consider the time-series cross-sectional

regression suggested by Fama and MacBeth (1974).


Model 2: Return Model


RETitA( B ) = β 0 + [ Eit ( IFRS ) / Pi (At(−B)) ] + β1[ Eit ( IFRS ) − EiCAS1()IFRS ) ) / Pi (At(−B)) ] + ε it
                        CAS
                                             1
                                                           CAS
                                                                          (t −                     1




                   A( B )
Where RET it                is the cumulative 12-month raw return for A- (B-) shares for firm i,




   investigate this issue, this study uses the return models for the robustness test purpose and finds very
   consistent results with the price model.



                                                                   14
                                                         CAS                (
starting from four months after prior fiscal year-end; Eit ( IFRS ) / Pi (At−B)) is CAS (IFRS)
                                                                              1



earnings per share, deflated by the prior year-end share price of A- (B-) share for firm i;

( Eit ( IFRS ) − EiCAS1()IFRS ) ) / Pi (At(−B)) is change in CAS (IFRS) earnings per share, deflated by the
    CAS
                   (t −                     1



prior year-end share price of A- (B-) share for firm i.


        In this study, all the slope coefficients of the above two regression models are

adjusted for White’s (1980) unbiased covariance to correct for heteroskedasticity. In

addition, we report adjusted R-squared values of the above regression models in the

following tables.


        Following previous studies (e.g. Collin et al., 1997; Francis and Schipper, 1999;

Eichenseher, 2000; Sami and Zhou, 2004), the explanatory power of accounting

information for share price or share return (i.e. adjusted R-squared value) is used as an

indicator of the value-relevance of accounting information. Hence, if H1 is true, then we

should observe a higher explanatory power of earnings and book value of shareholders’

equity (earnings and change in earnings) for share price (share return) in the post-

segmentation period versus the pre-segmentation period. On the other hand, if H2 is true,

then we should observe that the change in the explanatory power of earnings and book

value of shareholders’ equity for A-share price (return) is different from that for B- share

price (return) between the pre- and the post- segmentation periods. Following previous

studies, we also consider the statistical significance of slope coefficients of earnings, book

value of equity, and change in earnings in the above two regression models.




                                                   15
5. Sample Selection and Data Collection


       We include all the industrial firms issuing both A- and B- shares on the SHSE or

SZSE with all the accounting and market data available in the Taiwan Economic Journal

(TEJ) for the period of 1997-2005 (i.e. four years before and after 2001). We report our

empirical results using the whole sample because of two reasons. First, our empirical

results after deleting potential outliers (top and bottom 1% observations for each examined

variable) are qualitatively consistent with the results reported in this study; second, this

allows us to maximize our sample observations.


       Table 1 describes our sample characteristics. Panel A shows that our sample is

comprised of 705 (669) firm-years with price (return) data available in the TEJ database.

Only 622 firm-years have complete ownership data from TEJ. Panel B reports the

industrial sectors in which our sample companies operate. Around 42% of our sample

companies are in the manufacturing sector, which is the dominant industry in China,

followed by the real estate (13%), service and transportation (11%), electronic (9%), and

chemicals and metal (9%) industries.


       Panel C shows that more Chinese companies are listed on the Shanghai Stock

Exchange than Shenzhen Stock Exchange. Panel D reports the ownership distributions.

More than one third of the shares of our sample companies were owned by the State,

although the percentage of state shares was slightly reduced after 2000. Tradable share was

increased to nearly 50% from 45%, due to the split-share structure reform plan launched in




                                              16
2005, which was both statistically significant and economically material. Both domestic

and foreign institutional shareholdings slightly decreased. Public shareholding, i.e. shares

owned by individual investors, increased about 2.4%; shares traded on the Hong Kong

Exchange remain stable.


                                       [Insert Table 1]


6. Empirical Results


6.1. Descriptive Statistics


       Panel A of Table 2 shows that the mean and median share prices of A-shares are

consistently higher than those of B-shares, although their differences become smaller in

later years. A- and B- share prices reached their peak in 2000, an unusual year for the B-

share market because the average B-share price increased around four times compared to

the average price in 1999. B-share price appears to be significantly inflated after the

announcement of the change in the market segmentation policy. Both A- and B- share

prices significantly dropped in 2001 (about 16% and 27%, respectively) and continuously

decreased afterwards because of the impact of the fall of Internet share prices. Figure 1

shows that both A- and B- share prices and their price differences continuously decreased

after 2000. Untabulated results show that the mean price difference between A- and B-

shares reached its highest level in 1999 and was then reduced by 33%, 26%, 21%, and 53%

in years 2000, 2002, 2003, and 2004, respectively. The mean price difference, however,

increased by 1% in 2005, which was caused by increased share prices due to the split-share

plan. The mean A-share price was over six times higher than the mean B-share price in




                                              17
1999; the price difference, however, was reduced to around 1.5 times in 2005.


                                      [Insert Figure 1]


       Figure 2 shows that the mean and median trading volumes of A-shares were over

three times more than those of B-shares before 2000, while they were less than two times

more in 2000 and onwards. The average trading volumes of B-shares in 2000 and 2001

were extremely high, which were over 1.4 times and 1.9 times higher than those of A-

shares respectively. The above findings suggest that the change in the market segmentation

policy significantly increased both trading volume and share price of B-shares during the

transition period (i.e. 2000 and 2001). Overall, we find evidence that the price difference

between A- and B- shares was significantly reduced around the change in the market

segmentation policy in 2001.


                                      [Insert Figure 2]


       Panel B of Table 2 shows that the patterns of share returns for both A- and B-

shares are very similar except for 1999 and 2000. The mean and median share returns of B-

shares in 1999 and 2000 were 352% and 336%, respectively, over 14 times higher than

those of A-shares. B-share prices were significantly inflated in 1999 and 2000.


       Table 3 reports the descriptive statistics of the variables used for this study.

Consistent with Panel A of Table 2, the average A-share price is over two times higher

than the average B-share price during the entire test period. Untabulated results show that

the median A-share price is approximately five times (1.8 times) higher than the median B-

share price before 2000 (after 1999). Interestingly, both the mean and median earnings per



                                             18
share based on IFRS and CAS appear to be identical during the entire test period. As

documented by Eccher and Healy (2000), Chinese managers seem intend on reporting very

similar IFRS and CAS earnings. On the other hand, both the mean and median book values

of shareholders’ equity per share based on CAS are slightly greater than those based on

IFRS, although their differences appear to be insignificant. Untabulated results also show

that earnings and book values of shareholders’ equity based on IFRS and CAS are much

closer after 2000 because CAS has been further reformed to be aligned with IFRS.


        Panel B of Table 3 reports that A-share and B-shares have positive means but

negative median annual share returns, indicating their distributions are significantly

skewed. This is consistent with the finding that the standard deviations of the share returns

for both A- and B- shares are approximately 20 times higher than their mean annual share

returns. Untabulated results also show that the correlation coefficients between A-share

and B-share annual returns increase over time, indicating that both share markets become

more connected in recent years. Consistent with Panel A, the mean and median earnings

based on CAS and IFRS are identical when they are deflated by prior year-end price of A-

shares. The average earnings based on CAS are greater than those based on IFRS when

both earnings are deflated by prior year-end price of B-shares. The deflated mean and

median changes in earnings based on CAS are also slightly greater than those based on

IFRS.


                                      [Insert Table 3]




                                             19
6.2. Regression Results


       Panels A and B of Table 4 report the statistical associations between share price

and earnings and book value of equity for A- and B- shares, respectively. Panel A shows

that the explanatory power of CAS and IFRS earnings and book value of equity for A-

share price is generally low during 1998-2002 (i.e. 0.01-0.08). The slope coefficients of

earnings and book value of equity also appear to be very volatile. For example, the slope

coefficients of both CAS and IFRS earnings are negative in 1999 but become positive in

2000, although they are never significant in both years. They, however, become positive

and significant in 2001. The slope coefficients of both CAS and IFRS book value of equity

are extreme, but they are positive and significant only in 1999.


                                      [Insert Table 4]


       Three factors may have contributed to the above weak results. First, Chinese

domestic investors trade A-shares based on speculation (Mei, Scheinkman, and Xiong,

2005) instead of market fundamentals (Chen, Lee, and Rui, 2001), causing low

explanatory power of accounting information for share price and volatile slope

coefficients. Second, A-share prices were significantly inflated during this period. Previous

studies (Bailey and Jagtiani, 1994; Domowitz, Glen, and Madhavan, 1997) find that shares

that can only be traded by foreign investors have higher market prices than shares that can

only be traded by domestic investors in emerging capital markets such as Mexico and

Thailand. In contrast, A-shares that can only be traded by domestic investors in China have




                                             20
much higher share prices than B-shares that could only be traded by foreign investors

before 2001. A-share prices were significantly inflated because domestic investors could

not invest in the B-share market due to the market segmentation policy. Inflated and biased

A-share prices (i.e. dependent variable of the accounting-based valuation model) could

cause low explanatory power of accounting information for A-share price. Finally, it is

also possible that the implementation of new accounting standards, which first took effect

in 1998, was not effective because the new accounting system allows managers to exercise

more professional judgment to reflect the firm-specific business environment that their

companies face. Previous studies argue that the Chinese market infrastructure was still at

its early stage and was not ready to support fair value accounting (Eccher and Healy, 2000;

Chen et al., 2001). As a result, biased accounting information (i.e. independent variables of

the accounting-based valuation model) could drive the slope coefficients of earnings and

book value of equity to be downward biased.


       We observe completely different results during the period of 2003-2005. The slope

coefficients of CAS and IFRS earnings and book value of equity for A-share price are

generally significant and less volatile. The slope coefficients for earnings (book value) are

generally greater (less) than 1 except the earnings prepared by IFRS in 2003. More

importantly, the adjusted R-squared values of the price-accounting regressions

significantly increase especially when accounting information is prepared by CAS,

indicating that the change in the market segmentation policy indeed reduced the price

difference between A- and B- shares, which might have significantly increased the

association between share price and accounting information during this period.




                                             21
       Another interesting finding in the yearly A-share regressions is that the explanatory

power of CAS earnings and book value is fairly close to that of IFRS earnings and book

value, indicating that IFRS and CAS accounting information are equally considered in the

A-share stock market. Although the average explanatory power of accounting information

increases from 2% to 5% after 2000, Panel A clearly shows that the average explanatory

power for the period of 2003-2005 is much higher than that for the period of 1998-2002.

This indicates that the value-relevance of accounting information for A-shares was

significantly improved due to the change in market segmentation policy. Our empirical

evidence therefore supports H1.


       After partitioning our sample into the pre- and post- segmentation periods, we find

that only earnings (book value of equity) are associated with share prices in the pre- (post-)

market segmentation period. Moreover, only CAS earnings or IFRS book value of equity

can explain the variation of A-share price when using the entire test period. The

explanatory power of CAS earnings for A-share price is, however, identical to that of IFRS

book value of equity (i.e. 3%). Untabulated results using the time-series cross-sectional

regressions (Fama and MacBeth, 1974), however, show that either CAS or IFRS earnings

can explain the variation of A-share prices but not any book value of equity, indicating that

earnings are the dominant explanatory variable for the variation of A-share price.


       The above results generally suggest that both CAS and IFRS earnings and book

values of equity can explain the variation of A-share prices, which is consistent with

previous studies (e.g. Chen, Firth, and Kim, 2002; Sami and Zhou, 2004).


       Panel B of Table 4 shows that the adjusted R-squared values are high across the



                                             22
entire test period except years 2000 and 2001 when the trading volumes and share prices of

B-shares were unusually high (see Figure 2 and Panel A of Table 2). Although the

explanatory power of IFRS accounting information is higher than that of CAS accounting

information in 5 out of 9 examined years, the overall explanatory power of IFRS and CAS

accounting information for B-share price after 2000 are identical (i.e. 19%). The average

explanatory power of accounting information for B-share price significantly increases to

19% from 5% or 7% after 2000. Overall, the explanatory power of accounting information

for B-shares is high during the periods of 1997-1999 and 2003-2005. This indicates that

accounting information is generally value-relevant for B-shares across the entire test period

except the transition period of 2000-2001 and that the change in market segmentation

policy in China temporarily reduced the value-relevance of accounting information for B-

shares. The association between accounting information and B-share price returns to

normal after 2002.


       Compared to the findings reported in Panels A and B, we find that the increase in

the adjusted R-squared values of B-shares between the pre- and post- periods is between

12% and 14% (i.e. 19%-7% and 19%-5% when IFRS and CAS accounting information is

used respectively). On the other hand, the increase in the adjusted R-squared values of A-

shares is only between 2% and 3% (5%-3% and 5%-2% when CAS and IFRS accounting

information is used respectively). Hence, the impact of the change in market segmentation

policy on the explanatory power of accounting information for share price varies between

A- and B- shares. We therefore find evidence supporting H2.


       This study finds that both share markets benefit from the change in market




                                             23
segmentation policy in terms of increased associations between share price and accounting

information, although there is some evidence indicating that the B-share market benefits

more from the change in market segmentation policy than the A-share market. To further

investigate this issue, we compare the adjusted R-squared values of B-share price

regressions based on IFRS with those of A-share price regressions based on CAS. This

comparison is based on the argument that financial statements prepared and audited by

CAS (IFRS) are designed for the sake of domestic (foreign) investors. Figure 3

demonstrates that the adjusted R-squared values of IFRS earnings and book value for B-

share price are consistently higher than those of A-shares across the entire test period,

although the differences in their adjusted R-squared values appear to be smaller after 1999.

However, the explanatory power of accounting information for A-share price is apparently

higher in recent years (after 2002) than in early years, indicating that the usefulness of

accounting information in the A-share market also significantly benefits from the change in

market segmentation policy.


                                     [Insert Figure 3]


       The slope coefficients of CAS and IFRS earnings and book values are generally

associated with B-share prices across the test period except years 2000 and 2001.

Moreover, the slope coefficients of earnings and book values of equity for B-shares before

2003 are less volatile than those for A-shares. Consistent with some previous studies, we

find that CAS and IFRS accounting information are equally useful for B-share valuation.




                                            24
7. Robustness Test


Return model


       We perform three robustness tests in this section. First, we investigate the

association between share return and CAS and IFRS earnings and change in earnings in

both share markets. Second, we examine whether change in ownership structure in Chinese

companies in recent years has any implication for our finding. Finally, we investigate

whether further alignment between CAS and IFRS in the Chinese markets in recent years

has any implications on our finding.


       Panels A and B of Table 5 report the regression results using stock returns for A-

and B-shares, respectively. Panel A shows that the adjusted R-squared values are generally

very small during the period of 1998-2001, especially when using CAS earnings. After

2001, the adjusted R-squared values for CAS and IFRS earnings increase every year

except 2005 when A- and B- share prices significantly increase again due to the split-share

plan. Moreover, the adjusted R-squared values based on CAS earnings are generally higher

than those based on IFRS earnings, indicating CAS earnings may provide incremental

explanatory power for A-share return relative to IFRS earnings. This finding is consistent

with previous studies (e.g. Eccher and Healy, 2000; Chen, Chen, and Su, 2001; Chen,

Firth, and Kim, 2002). Overall, the explanatory powers of CAS and IFRS earnings for

share return increase 2% (12%-9%) and 3% (10%-8%) respectively after 2000.


       The joint slope coefficients of earnings and change in earnings based on CAS



                                            25
(IFRS) are statistically significant except 1998 and 1999 (1998, 1999, and 2002). This is

generally consistent with the findings using the price model. The joint slope coefficients of

CAS and IFRS earnings and earnings change are all positive and statistically significant in

both the pre- and post- segmentation periods.


                                       [Insert Table 5]


       Panel B shows very similar results to Panel A in that the adjusted R-squared values

for B-share regressions are high between 2002-2004 when using either CAS or IFRS

earnings. More importantly, the adjusted R-squared values of CAS earnings for B-share

returns are generally higher than those of IFRS earnings except for years 2001 and 2005.

This finding is again consistent with Panel A, but it is somewhat different from the results

reported in Panel B of Table 4 in that the explanatory power of IFRS earnings and book

value of equity is generally higher that that of CAS earnings and book value. Overall, the

explanatory powers of CAS and IFRS earnings increase 8% (10%-2%) and 9% (11%-2%)

respectively after 2000.


       The joint slope coefficients of earnings and change in earnings based on IFRS

(CAS) are statistically significant except for 1998, 1999, and 2001 (1998 and 2001). The

joint slope coefficients of CAS and IFRS earnings and change in earnings are all positive

and statistically significant in both the pre- and post- segmentation periods.


       Finally, the average change in the adjusted R-squared values for A-shares (2% to

3%) is lower than that of B-shares (8% to 9%) after 2000, which is consistent with the

findings reported in Table 4. This indicates that B-shares benefit more than A-shares from




                                              26
the change in the segmentation policy in terms of increased explanatory power of

accounting information for share returns.


       Following our analysis for the price model, we compare the adjusted R-squared

values of B-share return regressions based on IFRS with those of A-share return

regressions based on CAS. Figure 4 demonstrates that the adjusted R-squared values of

IFRS earnings and change in earnings for B-share returns are generally higher than those

for A-shares except years 2001 and 2004, although the differences in their adjusted R-

squared values appear to be more volatile than those using the price model.


       In summary, our empirical results using the return model are generally consistent

with the results using the price model in that the association between share price (and share

return) and accounting information, measured by earnings and book value of equity, is

improved in both the A- and B- share markets, although the increased association seems be

greater for B-shares. We therefore find consistent empirical evidence supporting both H1

and H2.


Ownership


       As shown in the Panel D of Table 1, the tradable and public shares appear to

adequately increase in the post-segmentation period. To investigate whether change in

ownership structure increases the explanatory power of earnings and book value of equity

for share price and return in this period, we partition our sample into two groups of

companies based on the median change in tradable and public shares between the pre- and

post- segmentation periods. Untabulated results show that there is no significant difference




                                             27
in the explanatory power between these two groups of companies in the post-segmentation

period.


Accounting reform


          We also examine whether further alignment between CAS and IFRS in the post-

segmentation period has any impact on the explanatory power of earnings and book value

of equity for share price and return. Untabulated results show that companies who report

exactly the same figures for both CAS and IFRS earnings and companies who report very

similar figures for both earnings (i.e. the difference between them is within 10% of IFRS

earnings) have higher explanatory power of earnings and book value of equity for share

price and return and more significant slope coefficients than the rest of the sample firms.

This finding suggests that further alignment between CAS and IFRS may also contribute to

the increased association between share price (and share return) and accounting

information in the post-segmentation period. Surprisingly, we find that about 34% of

Chinese listed companies report identical CAS and IFRS earnings figures in 2005. In the

same year, 20% of Chinese listed companies report very similar CAS and IFRS earnings

figures (i.e. their difference is within 10% of IFRS earnings). This is unexpected because

there are still significant differences between CAS and IFRS. Future research should

further investigate the incentives and consequences to report identical and similar CAS and

IFRS earnings figures.


8. Conclusions


          This paper examines whether the association between share price and accounting




                                            28
information, measured by earnings and book value of shareholders’ equity, has increased

after Chinese domestic investors were allowed to trade B-shares from February 2001. We

also predict the impact of the change in the market segmentation policy on A- and B- share

markets should be different because previous studies document that the association

between share price and accounting information in the two markets appear to vary before

the Chinese capital markets were fully segmented.


       Using Chinese data for the period 1997-2005, we find that the price difference

between A- and B- shares significantly reduced after the change in the market

segmentation policy was announced by the Chinese government in 2000. The association

between share price and accounting information, measured by earnings and book value of

equity, is much weaker for A-shares than B-shares when the Chinese stock markets were

fully segmented before 2001. The association between A-share price and accounting

information, however, significantly increases after 2002. In contrast, the price-accounting

association significantly decreased for B-shares during the transition period of 2000-2001

when both the share price and trading volume of B-shares were inflated. The price-

accounting association for B-shares, however, significantly increased after 2002. The

above results generally indicate that the usefulness of accounting information is

significantly improved after the change in the market segmentation policy.


       Further evidence shows that the increased explanatory power of earnings and book

value of equity for B-share price (and return) is generally higher than that of A-share price,

indicating that the change in the market segmentation policy has a greater impact on the B-

share market than the A-share market. We therefore find empirical evidence supporting our




                                             29
two hypotheses.


       We also provide the following additional evidence. First, consistent with previous

studies (e.g. Chen, Firth, and Kim, 2002; Sami and Zhou, 2004), we find that both CAS

and IFRS earnings and book values of equity can explain the variations of A- and B- share

prices, although CAS-based accounting information seems be able to better explain the

variations of A- and B- share prices than IFRS-based accounting information. Second, the

change in ownership structure in recently years does not contribute to the increased

association between share price and accounting information. Finally, we find that the

further alignment between IFRS and CAS may have contributed to the increased

association between share prices for A- and B- shares and accounting information. This

finding, however, coincides with the fact that many Chinese listed companies have

reported identical or similar CAS and IFRS earnings in recent years. Future research

should further investigate this issue using more sophisticated methodology.


       There are many studies examine how the quality of accounting information affects

share value. Different from most previous studies, this study contributes to accounting

literature by providing empirical evidence of the role of market condition and information

environment in the association between share price and accounting information in an

emerging market such as China.




                                            30
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                                          33
Figure 1: Price gap between A- and B- shares



                         15
     Stock Price



                         10
                                                                                             A-share
                                                                                             B-share
                          5

                          0
                               1997 1998 1999 2000 2001 2002 2003 2001 2005


Price: mean share prices of Shares A or B at the end of fourth month after fiscal year end




Figure 2: Trading volume gap between A- and B- shares


                                      A Share and B Share Trading Volume

                         600
   Mean Trading Volume




                         400
                                                                                             A share
                                                                                             B share
                         200


                          0
                               1997 1998 1999 2000 2001 2002 2003 2004 2005


Trading volume: mean 12-month cumulative trading volumes starting from end of fourth month of prior
year-end.




                                                        34
Figure 3: Adjusted R-squared values of regressing share prices on net income and
book value of shareholders’ equity based on CAS (IFRS) for A- (B-) share



                    0.8
    Adj R-squared



                    0.6
                                                                                           A-share
                    0.4
                                                                                           B-share
                    0.2

                     0
                              1997 1998 1999 2000 2001 2002 2003 2004 2005


They are adjusted R-squared values of regressing A (B) share prices on CAS (IFRS) earnings.




Figure 4: Adjusted R-squared values of regressing share return on earnings and
earnings changes based on CAS (IFRS) for A- (B-) share



                     0.5
                     0.4
    Adj R-squared




                     0.3
                                                                                              A Share
                     0.2
                                                                                              B Share
                     0.1
                          0
                     -0.1
                               1997 1998 1999 2000 2001 2002 2003 2004 2005


They are adjusted R-squared values of regressing 12-month cumulative share returns for A (B) shares on
CAS (IFRS) earnings and change in earnings.




                                                      35
 Table 1: Sample Selection
 Panel A: Non-financial firms issuing both A and B shares
                     1997     1998    1999      2000    2001      2002      2003   2004        2005      Total
 With price          72       76      79        84      80        83        85     78          68        705
 With return         60       67      76        79      83        82        80     79          63        669
 With ownership      60       64      68        74      79        76        78     68          55        622


 Panel B: Industry Classification
 Industry Classification                                       Percentage
 Manufacturing                                                 42 %
 Electronics                                                   9%
 Real Estate                                                   13 %
 Chemicals and Metal                                           9%
 Service and Transportation                                    11 %
 Conglomerate                                                  16 %


 Panel C: Stock Exchanges
 Stock Exchange                                                Percentage
 Shenzhen                                                      48 %
 Shanghai                                                      52 %


 Panel D: Ownership Structure
                                       Before 2001     After 2000        Differences           t-test
 Tradable Shares                       45.17 %         49.36 %           4.19 %                3.68***
 Foreign    Institutions               3.29 %          1.94 %            -1.35 %               -1.91*
 Domestic Institution                  12.95 %         10.25 %           -2.70 %               -1.93*
 States Shares                         35.49 %         33.93 %           -1.56 %               -0.53
 Public Holdings                       15.67 %         18.35 %           2.68 %                2.42**
 Hong Kong Shares                      29.39 %         30.02 %           0.63 %                1.59
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively.




                                                       36
  Table 2: Descriptive statistics
  Panel A: Mean and median stock price (705 observations)
                                                         Mean Share Price              Median Share Price

                 Year                      Obs.         A share        B share        A share            B share

                 1998                       76              7.31           1.23           7.11             0.95

                 1999                       79             11.57           1.95         11.41              1.71

                 2000                       84             14.15           7.75         13.23              7.39

                 2001                       80             11.89           5.66         11.71              5.54

                 2002                       83              8.86           4.27           8.46             4.29

                 2003                       85              7.81           4.22           7.61             3.91

                 2004                       78              4.72           3.04           4.09             2.43
                 2005                       68              5.45           3.76           4.64             2.95



  Panel B: Mean and median return (669 observations)
                                                            Mean Return                  Median Return

                 Year                      Obs.         A share        B share        A share            B share

                 1997                       60           -0.067          -0.372         0.129             -0.409

                 1998                       67           -0.134          -0.344         -0.168            -0.362

                 1999                       76             0.713         0.886          0.565             0.791

                 2000                       79             0.230         3.524          0.233             3.359

                 2001                       83           -0.167          -0.270         -0.171            -0.263

                 2002                       82           -0.183          -0.175         -0.244            -0.171

                 2003                       80           -0.089          0.011          -0.146            -0.041

                 2004                       79           -0.362          -0.304         -0.431            -0.423

                 2005                       63             0.251         0.224          0.209             0.203



Note:
This study uses share prices at the end of the fourth month after fiscal year end. Returns are the 12-
month cumulative raw return ending at the end of the fourth month after fiscal year end.




                                                      37
 Table 3: Descriptive Statistics
 Panel A: Variables for price model (1997-2005)
 Variables                                                        Mean            Median              S.D.              Q1                  Q3
 PA                                                               9.11             8.17               4.70              5.80            11.65
       B
 P                                                                3.85             3.31               2.70              1.69            5.38
       IFRS
 E                                                                0.09             0.12               0.58              0.01            0.30
            IFRS
 BV                                                               2.33             2.33               1.72              1.56            3.17
 ECAS                                                             0.09             0.12               0.50              0.01            0.28
            CAS
 BV                                                               2.38             2.36               1.70              1.58            3.29
       IFRS-CAS
 E                                                                0.00             0.00               0.29             -0.03            0.01
            IFRS-CAS
 BV                                                               -0.05            -0.01              0.48             -0.01            0.03

Panel B: Variables in the return model (1997-2005)
Variables                                                         Mean            Median              S.D.               Q1                 Q3
               A
RET                                                               0.022           -0.095             0.439             -0.265           0.240
               B
RET                                                               0.027           -0.123             0.522             -0.344           0.348
       CAS         A
E it / Pi (t −1)                                                  0.008            0.011             0.062              0.001           0.030
               − E i (t −1)) / Pi (t −1)
       CAS              CAS             A
( E it
                                                                  -0.001           0.000             0.070             -0.011           0.008
       IFRS         A
E it          / Pi ( t −1)
                                                                  0.008            0.011             0.072              0.005           0.030
               − E i (t −1)) / Pi (t −1)
        IFRS            IFRS            A
( E it
                                                                  -0.003          -0.001             0.085             -0.013           0.009
       IFRS        B
E it          / Pi ( t −1)
                                                                  0.013            0.030             0.248              0.001           0.082
               − E i (t −1)) / Pi (t −1)
        IFRS            IFRS            B
( E it
                                                                  0.000           -0.002             0.275             -0.041           0.027
       CAS         B
E it / Pi (t −1)                                                  0.018            0.030             0.231              0.005           0.082
               − E i (t −1)) / Pi (t −1)
       CAS              CAS             B
( E it
                                                                  0.000            0.000             0.241             -0.032           0.019

PA(B) denotes the share prices of A- and B- shares at the end of the fourth month after fiscal year-end;
   P




ECAS (IFRS) denotes the earnings per share based on CAS (IFRS);
BVCAS (IFRS) denotes the year-end book value of shareholders’ equity based on CAS (IFRS).
 RETitA( B ) denotes the cumulative 12-month raw returns of A- and B- shares for firm i, starting from the
end of fourth months of prior year end;
        CAS ( IFRS )           A( B )
 E it                   / Pi (t −1)         denotes earnings per share based on CAS (IFRS) for firm i, deflated by prior year-end
prices of A- (B-) shares;
                          − E i (t −1)
           CAS ( IFRS )           CAS ( IFRS )          A( B )
 ( E it                                          ) / Pi ( t −1)    denotes the change in CAS-(IFRS-) based earnings per share for firm i,
deflated by prior year-end share prices of A- (B-) shares.




                                                                                           38
 Table 4: Association between share prices and earnings and book value of
 shareholders equity
 Panel A: A shares price regression model

 Model 1: PitA = α 0 +α 1Eit ( IFRS ) + α 2 BVitCAS ( IFRS ) + ε it
                           CAS


                             CAS              CAS                           IFRS            IFRS

      Year               E               BV             Adj R2          E              BV            Adj R2
      1997              5.03**            0.66           0.21          6.49***           0.14         0.24
                        (2.46)           (1.03)                         (2.98)          (0.21)
      1998               1.45*            0.22           0.08            1.16            0.35         0.07
                        (1.82)           (0.65)                         (1.08)          (0.96)
      1999               -2.31          1.24***          0.05           -2.05          1.02**         0.03
                        (-1.19)          (2.65)                        (-1.14)          (2.07)
      2000               1.99             -0.80          0.01            3.96          -1.13**        0.03
                        (0.55)           (-1.39)                        (1.27)         (-2.03)
      2001             1.47***            -0.35          0.05          1.09**           -0.27         0.03
                        (2.74)           (-1.14)                        (2.47)         (-1.08)
      2002               1.20             0.04           0.01          1.45***           0.01         0.06
                        (1.35)           (0.18)                         (3.03)          (0.02)
      2003             2.18***           0.28**          0.23            0.26          0.48***        0.15
                        (2.95)           (2.48)                         (0.30)          (4.07)
      2004             1.68***          0.46***          0.42          1.11***         0.60***        0.41
                        (2.67)           (3.79)                         (3.4.)          (4.48)
      2005             5.26***            0.11           0.41          3.92***         0.32**         0.31
                        (4.16)           (0.78)                         (3.43)          (2.28)
 < = 2000              3.38***            -0.36          0.03          3.15***          -0.27         0.02
                        (3.24)           (-1.17)                        (2.96)         (-0.90)
 > = 2001                0.71           0.29***          0.05            0.09          0.44***        0.05
                        (1.49)           (2.94)                         (0.29)          (5.27)
    All years           1.32**            0.19           0.03            0.40          0.40***        0.03
                        (2.80)           (1.60)                         (1.13)         (3.94.)
***Significant at the 0.01 level; **Significant at the 0.05 level; *Significant at the 0.1 level


PA(B): Share prices of A- and B- shares at the end of fourth month after fiscal year-end;
ECAS denotes earnings per share based on CAS;
BVCAS denotes the year-end book value of shareholders’ equity based on CAS;
All the t statistics are adjusted for Whites’ (1980) unbiased covariance to correct for heteroskedasticity.




                                                      39
 Panel B: B share price regression model

 Model 1: PitB = α 0 +α 1E it (CAS ) + α 2 BVitIFRS (CAS ) + ε it
                            IFRS


                                                 IFRS        IFRS                       CAS           CAS

                      Year                   E          BV            Adj R2       E             BV         Adj R2
                       1997                2.48***        0.43                    1.94**         0.56**
                                                                       0.39                                  0.33
                                            (2.74)       (1.84)                   (2.05)         (2.21)
                       1998                  0.25       0.55***                    0.32          0.49***
                                                                       0.54                                  0.48
                                            (0.96)       (5.19)                   (1.19)         (4.56)
                       1999                  0.49       0.47***                    0.95*         0.39***
                                                                       0.42                                  0.43
                                            (1.35)       (5.28)                   (1.94)         (4.17)
                       2000                  2.94        -0.24                     1.98           -0.11
                                                                       0.03                                  0.01
                                            (1.45)      (-0.90)                   (0.92)         (-0.35)
                       2001                  0.08        0.21*                     0.20           0.17
                                                                       0.07                                  0.07
                                            (0.35)       (1.78)                   (0.75)         (1.24)
                       2002                0.54***       0.14*                     0.60*         0.15**
                                                                       0.15                                  0.12
                                            (3.28)       (1.85)                   (1.87)         (1.77)
                       2003                  0.43       0.41***                   1.23**         0.31***
                                                                       0.31                                  0.35
                                            (1.01)       (4.94)                   (2.24)         (3.73)
                       2004                0.82***      0.67***                   1.29**         0.55***
                                                                       0.49                                  0.50
                                            (2.83)       (4.59)                   (2.26)         (4.08)
                       2005                5.71***      0.30**                   3.72***         0.53**
                                                                       0.58                                  0.45
                                            (4.33)       (2.47)                   (2.84)         (2.22)
                     < = 200                1.62**        0.30                   1.90***          1.12
                                                                       0.07                                  0.05
                                            (2.57)       (1.34)                   (3.11)         (0.49)
                                             0.17       0.44***                    0.38          0.41***
                     > = 2001                                          0.19                                  0.19
                                            (0.65)       (8.93)                   (1.08)         (6.98)


                                             0.32       0.44***                    0.56          0.36***
                     All years                                         0.10                                  0.09
                                            (1.09)       (7.65)                   (1.61)         (5.54)

***Significant at the 0.01 level; **Significant at the 0.05 level; *Significant at the 0.1 level


    A( B )
P            : Share prices of A or B shares at the end of fourth month after fiscal year-end;
    IFRS
E             denotes earnings per share based on IFRS;
             IFRS
BV                  is the year-end book value of shareholders’ equity based on IFRS;

All the t statistics are adjusted for Whites’ (1980) unbiased covariance to correct for heteroskedasticity.




                                                                 40
Table 5: Association between annual return and earnings and change in earning
Panel A : A share return model

           Model 2: RETit =
                                             A
                                                         β 0 + [ Eit ( IFRS ) / Pi (At −1) ] + β1[ Eit ( IFRS ) − EiCAS1()IFRS ) ) / Pi (At −1) ] + ε it
                                                                   CAS                               CAS
                                                                                                                    (t −

                        CAS          A                                                            Adj        IFRS         A                                                            Adj
 Yr                 E   it
                               / Pi (t −1)       ( E it − E i (t −1) ) / Pi ( t −1)
                                                      CAS        CAS         A

                                                                                       F-stat.    R2     E   it
                                                                                                                    / Pi ( t −1)       IFRS
                                                                                                                                   ( E it     − E i (t −1)) / Pi ( t −1)
                                                                                                                                                     IFRS         A

                                                                                                                                                                           F-Stat.     R2

1997                     1.99*                              1.88*                                             1.73*                         2.61**
                                                                                      14.07***    0.14                                                                     12.48***    0.15
                         (1.81)                          (1.87)                                               (1.85)                          (2.25)
1998                         -0.36                          0.83                                    -    -1.08**                            1.67**
                                                                                        0.40                                                                                 0.60      0.05
                        (-0.88)                          (1.46)                                   0.02       (-2.21)                          (2.61)
1999                         0.54                           2.21*                                                 0.33                         1.92
                                                                                        1.82      0.03                                                                       2.57      0.10
                         (0.38)                          (1.88)                                               (0.25)                          (1.64)
2000                         0.16                       3.54**                                                    0.19                      3.33**
                                                                                       6.00**     0.02                                                                     9.50***     0.05
                         (0.18)                          (1.99)                                               (0.22)                          (2.34)
2001                         0.18                           0.17                                                  0.29                         0.11
                                                                                       3.02*      0.03                                                                      4.48**     0.06
                         (0.36)                          (0.29)                                               (0.70)                          (0.22)
2002                  3.07***                               0.18                                             1.23**                           -0.25
                                                                                       6.33**     0.27                                                                       2.62      0.12
                         (2.92)                          (0.35)                                               (2.49)                        (-1.60)
2003                  1.70***                               -0.13                                        1.55***                              -0.31
                                                                                      11.76***    0.21                                                                     12.18***    0.16
                         (4.71)                         (-0.52)                                               (5.05)                        (-1.19)
2004                  3.08***                          -0.98**                                               2.78**                         -1.40*
                                                                                      9.86***     0.39                                                                      6.90**     0.27
                         (3.67)                         (-0.28)                                               (2.64)                        (-1.67)
2005                         1.05                           0.05                                             1.28**                            0.17
                                                                                       2.95**     0.02                                                                      5.42**     0.06
                         (1.56)                          (0.11)                                               (2.24)                          (0.58)

<=                           0.19                     3.66***                                                     -0.05                     3.44***
                                                                                      15.15***    0.09                                                                     14.22***    0.08
2000                     (0.27)                          (4.50)                                              (-0.07)                          (3.94)
                     1.73***                           -0.40**                                           1.39***                            -0.43**
>=
                                                                                      13.77***    0.12                                                                      12.79***   0.10
2001                     (5.20)                         (-2.01)                                               (4.99)                        (-2.37)

 All                  1.46***                               0.22                                         1.12***                               0.07
                                                                                      22.14***    0.05                                                                     19.82***    0.03
years                    (4.20)                          (0.60)                                               (3.95)                          (0.28)
 ***Significant at the 0.01 level; **Significant at the 0.05 level; *Significant at the 0.1 level

   A
RET is the 12-month cumulative raw return of A-shares for firm i ending at the end of the fourth month
after the fiscal year-end;
  CAS ( IFRS )        A( B )
E it             / Pi (t −1)     is earnings per share based on CAS (IFRS), deflated by prior year-end share price of A- (B-)
shares for firm i for period t.
All the t statistics are adjusted for Whites’ (1980) unbiased covariance to correct for heteroskedasticity.




                                                                                                 41
Panel B: B share return model

                           Model 2: RETit =
                                                                  B
                                                                                β 0 + [ Eit ( IFRS ) / Pi (Bt −1) ] + β1[ Eit ( IFRS ) − EiCAS1()IFRS ) ) / Pi (Bt −1) ] + ε it
                                                                                          CAS                               CAS
                                                                                                                                           (t −

                                                                                                                 Adj           CAS         B                                           Adj
                                                                                                                                                     (E −E(t −1))/P(t −1)
                  IFRS        B                                                                                                                        CAS     CAS   B

Year          E /Pit          i(t −1)
                                               ( E it
                                                        IFRS
                                                               − E i (t − 1)) /
                                                                         IFRS
                                                                                   P
                                                                                       B
                                                                                       i ( t − 1)    F-stat.     R2          E /P
                                                                                                                               it          i(t −1)     it i        i
                                                                                                                                                                             F-stat    R2
1997                       0.06                                 1.50***                                                         0.38*                     0.75**
                                                                                                    23.94***     0.29                                                       12.30***   0.17
                       (0.32)                                     (4.16)                                                       (1.71)                     (2.30)
 1998                  -0.02                                        0.12                                           -                0.38                     0.48
                                                                                                      0.83                                                                    1.76     0.003
                       (-0.28)                                    (0.94)                                         0.02          (0.90)                     (0.68)
 1999             -0.22**                                        0.38**                                                       -0.21**                    0.45***
                                                                                                      1.34       0.09                                                        3.79*     0.13
                       (-1.99)                                     (259)                                                       (-1.76)                    (3.51)
 2000                  -0.79                                     2.86**                              3.03*                      -0.84                    3.97***
                                                                                                                 0.08                                                       7.39***    0.09
                       (-0.49)                                    (2.29)                                                       (-0.76)                    (2.67)
 2001                  .-0.22                                       0.40                                                        -0.28                        0.38
                                                                                                      1.21       0.02                                                         0.43     -0.01
                       (-0.72)                                    (1.24)                                                       (-0.79)                    (0.95)
 2002             0.87***                                          -0.04                                                      1.33***                        0.06
                                                                                                     8.66**      0.31                                                       13.09***   0.38
                       (3.78)                                    (-0.52)                                                       (4.14)                     (0.42)
 2003             1.24***                                          -0.15                                                      1.49***                        0.05
                                                                                                    12.34***     0.21                                                       22.79***   0.29
                       (3.86)                                    (-0.99)                                                       (4.36)                     (0.30)
 2004                  1.47**                                      -0.59                                                      2.22***                     -0.72*
                                                                                                     6.75**      0.22                                                       11.49**    0.38
                       (2.60)                                    (-1.23)                                                       (3.67)                     (-1.68)
 2005                  0.61**                                       0.20                                                            0.06                     0.53
                                                                                                    9.51***      0.07                                                        7.83**    0.04
                       (2.21)                                     (1.41)                                                       (0.16)                     (1.47)

  <=                   -0.12                                     0.91**                                                         -0.12                    1.05***                       0.02
                                                                                                     4.88**      0.02                                                       11.21***
 2000                  (-0.42)                                    (0.99)                                                       (-0.44)                    (2.95)

  >=              0.80***                                          -0.10                                                      0.89***                        -0.06
                                                                                                    16.29***     0.10                                                       10.69***   0.11
 2001                  (4.78)                                    (-1.17)                                                       (4.02)                     (-0.55)

  All                      0.05                                 0.63***                                                             0.18                 0.74***
                                                                                                    11.14***     0.02                                                       14.99***   0.02
 years                 (0.19)                                     (2.73)                                                       (0.64)                     (3.37)
          ***Significant at the 0.01 level; **Significant at the 0.05 level; *Significant at the 0.1 level

                       B
         RET                is the 12-month cumulative raw return of B-shares for firm i ending at the end of the fourth month
         after the fiscal year-end;
                             − E i (t −1)
             CAS ( IFRS )               CAS ( IFRS )            A( B )
         ( E it                                        ) / Pi ( t −1)     is change in CAS (IFRS) based earnings per share for firm i for period t, deflated
         by prior year-end price of A- (B-) shares;
         All the t statistics are adjusted for Whites’ (1980) unbiased covariance to correct for heteroskedasticity.




                                                                                                                42