A (partial) resolution of the Chinese discount puzzle: The 2001 deregulation of the B ‐share market

The purpose of this paper is to examine the changes in B-share discounts across 76 Chinese stocks around an important regulatory event to understand the importance of political risk in pricing stocks in emerging markets. On Feb 19, 2001, the Chinese Securities Regulatory Commission announced that Chinese residents would be allowed to own B-share classes of stocks traded on both the Shanghai and Shenzhen stock markets. These share classes were previously restricted to foreign investors while domestic residents were only permitted to hold A-share classes of stock and were typically priced at a significant discount. This regulatory change triggered a dramatic decline of prevailing B-share discounts from 80% down to 40%. The paper finds that the largest declines in the B-share discounts around this regulatory event are concentrated in the firms with low government ownership stakes and are unrelated to the firms' risks, relative supplies of shares outstanding and liquidity attributes. This surprising finding challenges the current wisdom about what influences the B-share discount and particularly the role of political risk in explaining the discount puzzle. The paper offers an alternative interpretation for the B-share discount puzzle. The findings have important implications for China's future financial liberalization policies.