Financial distress resolution in China – two case studies

FINANCIAL DISTRESS RESOLUTION IN CHINA – TWO CASE STUDIES Amy Kam1 Augustus Asset Managers Limited

David Citron City University London - Sir John Cass Business School

Gulnur Muradoglu City University London - Sir John Cass Business School

Abstract This paper examines two financially distressed companies and their restructuring strategies. The existing distress literature focuses on developed economies such as U.S. and U.K. This paper is a pioneering work in an emerging market context. The main purpose of the case studies is to provide rich in-depth evidence on complex events which large-scale empirical studies of necessity ignore. To achieve this, the paper first analyses the firms’ accounting-based performance, both pre- and post-distress, to understand the nature of the firms’ difficulties. It then examines the series of complex restructuring procedures each firm initiated and uses an event study approach to evaluate the stock market’s reaction to these strategies. We provide an in-depth understanding of the special features of the Chinese situation, such as the role of government and other more commercially driven shareholders; the subsequent importance of social policy issues; the protracted and complex nature of the restructurings; and the frequent use of mergers, share transfers, asset swaps and asset sales. The analysis provides new hypotheses for further empirical study on a large-scale basis. JEL classifications: P27, G34, L10, G33. Keywords: Distress, Restructuring, Emerging Markets, Case Studies.

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Corresponding author. Augustus Asset Managers Limited, Bevis Marks House, 24 Bevis Marks, EC3A 7NE. Tel. +44 (0) 207 711 6718. Email. [email protected].

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1. INTRODUCTION This paper examines two financially distressed companies in China. It discusses details of their motivations, the distress resolution strategies they employed and the valuation effects of their restructuring announcements. Both companies choose a combination of restructuring strategies for recovery prior to and during distress. Financial distress and related recovery attempts are complex processes by their very nature. By examining two representative Chinese cases in detail, this paper provides rich in-depth data on those complex events, a thorough understanding of unique features for China as an emerging market, and an essential platform for further investigation of the topic using large sample sizes.

The effects of distress resolution have been studied extensively in developed economies. To name a few, Asquith et al (1994), Franks et al. (1996), Franks and Sussman (2000), Weston et al. (2001), Kahl (2001), Franks and Sanzhar (2003). However there are very limited studies in the emerging market context. In China, where bankruptcy law is in its infancy and where the state is still heavily involved as a shareholder, the process of distressed company restructuring is likely to differ markedly from that observed in the U.S. and the U.K. The conditions are similar in other emerging markets that are in the process of liberalisation. In that sense the Chinese cases are important for a thorough understanding of company distress and possible recovery attempts in emerging economies where firms find themselves in a competitive environment and yet developing legal and regulatory frameworks. Case study methodology has been widely employed in finance research literature (Ruback 1983, DeAngelo et al. 2002, Baldwin and Mason 1983). We adopt this methodology as it allows us to explore the less well-known features of the distress resolution process in the Chinese institutional context and to investigate how it differs from the process in more developed economies on an in-depth basis.

The first case, Shandong Jintai is a non-government controlled pharmaceutical company operating in a growing and liberalised industry consisting of 60 listed firms. The second, Sichuan Joint-WIT Medical, on the other hand, is a state-owned enterprise (SOE) in the state-controlled clothing and fabric industry consisting of five listed SOEs. These two companies were chosen for three main reasons. Firstly they are representative of state-controlled versus liberalised industries and ownership structures, and therefore provide insights into the different ways in

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which a privately owned company and an SOE cope with distress, and how the market reacts to their turnaround strategies. Secondly a comparison of the two cases sheds light on the role of government in distress resolution. Finally they provide an information-rich context to understand the use of various forms of mergers and acquisitions (M&A), asset sales, asset swaps and debt restructuring in comparison to what has been documented in the literature to date.

As the existing literature shows, firms suffering from performance decline may choose a variety of financial and non-restructuring strategies to reverse the decline. Financial strategies include debt and equity restructuring, while non-financial strategies can entail asset, operational and managerial changes. These restructuring strategies have been studied extensively in the U.S. and U.K. frameworks, and in other developed economies such as Germany, Japan and France (see for example Gilson et al 1990, Clark & Ofek 1994, Asquith et al 1994, Franks & Sussman 2000, Franks & Sanzhar 2003, Lai & Sudarsanam 1997, Furtado & Rozeff 1987, Denis & Denis 1995, Dherment-Ferere & Renneboog 2002).

In the Shandong Jintai and Sichuan Joint-WIT cases studied here, four well-documented restructuring strategies are observed: asset restructuring including M&A and asset sales/swaps; managerial restructuring (changes of board members, CEOs and general managers); operational restructuring; and, to a small extent, debt restructuring. There are, however, a number of key features in these cases that significantly differentiate them from restructuring processes observed in developed economies. Firstly, the process is highly complex and long-drawn out. Secondly, the (non-tradable) shares and underlying assets of the distressed firm are sometimes transferred to other entities without payment being made in return. In addition social considerations play a role, in particular the state’s need to maintain employment levels. Finally, while the business operations of a company may be transferred into new ownership, care is taken to retain the original company shell as it provides ready entry to a much-valued stock exchange listing. Related to this last point, equity restructuring such as spin-offs, equity carve-outs, tracking stock, and split-ups are not observed. Because the two Chinese stock exchanges impose strict rules on firms wishing to issue further equity, it is very difficult even for profitable firms to issue additional equity, let alone the distressed ones (Chen and Yuan, 2001).

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The paper is organized as follows. Section 2 discusses the institutional features of China; section 3 describes our data source and the event study methodology; section 4 presents our case study analyses; section 5 discusses the findings; and section 6 concludes.

2. THE INSTITUTIONAL BACKGROUND China is the most important emerging market and is in the process of financial liberalisation from a closed economy to a market oriented and an open economy. This section discusses the role of banks as a main source of finance for listed companies; role of the stock exchanges and the continuing role of government in the economy. In addition, we also briefly discuss the key features of the existing bankruptcy laws and their role in firm distress resolution.

2.1 Bank lending Due to historical reasons, banks are the main channel of funds from savers to borrowers. According to Tian (2004) and Allen et al. (2004), China is a bank economy. The Chinese financial landscape is dominated by “the big four” state owed banks: Industrial & Commercial Bank of China (ICBC), Bank of China (BoC), Construction Bank of China (CCBC) and Agricultural Bank of China (ABC), and they are highly inefficient2. There was also significant government intervention in bank lending prior to 1994. Such government intervention could take place either ex ante or ex post of bank lending being made (Lu et al 2001). Since 1994, the Chinese State banks have been granted increasing autonomy in their lending decision-making. Despite this evidence suggest that the banks’ lending decisions are systematically biased in favour of SOEs (Lu et al 2001).

2.2 Role of stock exchanges and the government in the corporate sector China’s privatisation process in the past two decades has dramatically transformed the structure of its corporate ownership. In particular, China’s share issue privatisation (SIP) of SOEs was a catalyst for the development of its two stock exchanges - Shanghai Securities Exchange (SHSE) and Shenzhen Stock Exchange (SZSE) in 1990 and 1991 respectively. At the outset the stock exchanges were used primarily to supply capital to SOEs.

By 2003, the total market

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The cost/income ratio of mainland Chinese banks is among the highest in the world, averaging close to 80%, versus 35-45% in Asia and 40-55% internationally (Bank of China International 2002).

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capitalisation of the two stock exchanges was 43.5% of GDP. Together the two stock exchangeswere ranked as the 12th largest in the world. Despite their rapid growth, in 2000 total capital raised in these stock markets accounted for the equivalent of only 15.8 % of new bank lending over the whole economy in the same year, and total market capitalisation of stocks was 48.4% of the total loans outstanding in China (McKinsey 2003). In addition, Tian (2004) documents that listed companies’ total liabilities are 43% of total assets, and bank loans are approximately 22% of total assets.

Although Chinese publicly listed companies (PLC) are organised and operated under the model of modern western firms, their shareholding structures are different from those of western firms in order to allow for continued state control of these listed firms. In other words, one of the main characteristics of Chinese listed companies is that the State remains in control of many enterprises that were formerly wholly State-owned enterprises.3 Therefore the Chinese government has keen interest and critical role in the process and issues of China’s transition from a planned economy to a market-orientated economy. Underpinning the social contract is the belief that the state would continue to look after the welfare of the individual. The government now has to delicately balance the often antagonistic tensions of rapid economic reform and sustaining social stability.

Due to the popularity of the equity market as a source of capital for Chinese firms, coupled with limitations on the capacity of the two exchanges to absorb large numbers of new listings, the stock exchanges impose strict listing requirements on company size and profitability. In addition they impose even stricter rules on firms wishing to issue further equity, as a result of which it is very difficult even for profitable firms to issue additional equity, let alone the distressed ones. In addition, according to the Company Law (Article 157 & 158), firms which have been making losses for two consecutive years are categorized as “special treatment” (ST) and are limited to 5% share-price movements up or down daily; whereas firms that have been making losses for three

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Strictly speaking, an SOE is a wholly State-Owned Enterprise (100%). Here we extend the definition to include all state-controlled enterprises (i.e. the state holds less than 100% shares) as SOEs. By construct, all listed SOEs have less than 100% state-owned shares as at least a portion of the shares are listed and held by individuals and institutions. In addition, if an SOE has over 50% state-owned shares, we consider it under the absolute control of the state. If, however, the state holds less than 50% of the shares but is still the largest shareholder, the enterprise is under the relative control of the state and is also classified as an SOE. For a thorough discussion of the difference between relative and absolute state control, see Kam et al (2005) and Clarke (2003).

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consecutive years are placed in “Particular Treatment” (PT) status and are suspended from the Exchange. These PT firms are given a maximum of a one-year grace period to return to profitability, failing which they are de-listed from the Stock Exchange. This feature is taken into consideration when designing our event study methodology.

2.3 Bankruptcy law Chinese Bankruptcy Law was initially promulgated to restructure or liquidate insolvent SOEs. As China began to move towards a more market driven economy additional bankruptcy4 legislation was enacted. Similar to many other countries, when a company is in distress, there are two possible routes for distress resolution: 1. Private workouts; 2. Bankruptcy process during which the company may be restructured under court supervision or liquidated. However, despite the existence of a legal procedure for the restructuring and/or liquidation of corporations, this process is seldom used. According to the World Bank (2000) and to the best of our knowledge, there have been no known cases of in-court restructuring in China5. The inefficiency of the bankruptcy laws, coupled with the pressure for the government to maintain social stability, contribute toward keeping non-viable firms alive.

3. DATA AND METHODOLOGY 3.1 The case companies The two distressed cases were selected from the 100 companies that constitute the full population of distressed companies listed in China studied in Kam et al (2005). A firm is classified as distressed if its earnings before interest, tax, depreciation, and amortisation (EBITDA) are less than its reported interest expense. This definition is also consistent with Asquith et al (1994), Kahl (2001), and Rajan & Zingales (1995). Further criteria for selection of the two case companies from the sample of distressed firms are firstly that one should have government and the other non-government controlling shareholders and, secondly, that between them they engaged in all the major restructuring categories, i.e. asset, operational, managerial and financial..

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The term “bankruptcy” follows the US definition and refers to the corporate bankruptcy process of court supervised restructuring or liquidation, and is used interchangeably with “insolvency” in this study. 5 As pointed out by George Nast, principal consultant at McKinsey&Co China, in a communication with the authors, this situation is not unique to China. Distress resolution tends to be informal in many emerging markets and distressed firms tend to be kept alive much longer (the so called soft budget constraint syndrome (Kornai 1980)).

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Data for the two cases’ operating performance and capital structure are collected from Thomson Financial Analytics Database.

Industry performance controls, capital structure, and size

comparisons are also collected from this database by matching the sample firms’ principal fourdigit code with other public firms with the same principal SIC code for the same year. Shandong Jintai and Sichuan Joint WIT’s accounts-based performance summaries are presented in Table 1 and 3, respectively.

The two distressed companies’ restructuring announcements are obtained from the two Chinese stock exchanges’ official websites. Appendix 1 presents the CSRC official ‘format of announcement requirement’ for listed companies (this has been translated by one of the authors). Details of the two companies’ restructuring related announcements6 are presented chronologically in Appendix 2 and 3 respectively. Further data for the case analyses are obtained from the companies’ annual reports and from news articles published on the stock exchanges’ official websites.

3.2 Market reaction to financial distress and restructuring announcements

In order to investigate market’s reaction to financial distress and related restructuring announcements we used event study methodology. The event day (t=0) is defined as the day when the firm announces its restructuring event as recorded on the official stock exchange website. However there might be information leakages before the announcement or drifts after the announcement in restructuring related events and therefore we use a wider event window of eleven days ( t=-5,..0,..+5). We calculate expected returns using the commonly used market model. We select a neutral period to estimate the market model. In the Shandong Jintai case, the company became distressed in 2002 and the first restructuring related announcement is on the 17th of December 2001; we use the estimation period as the first 95 days7 since listing (23/07/01 – 30/11/01).

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Restructuring related announcements made in a multiple announcement together with other news are excluded. We also repeat all analysis excluding the first 5 days of listing in the Shandong Jintai case and results do not change. 7

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In the Sichuan Joint-WIT case, since the company became distressed in Year 2001 and the first restructuring related announcement was made on 30th December 2000, we define the estimation period as 21/03/2000-25/12/2000. There are 200 daily observations in this estimation period Abnormal returns (ARjt) for company j at time t are calculated as the difference between the daily returns and their expected values (i.e the respective market returns), and related Cumulative Abnormal Returns (CAR) are calculated as follows: (1)

AR jt = R jt − R mt CAR j =

∑ AR

(2)

jt

t∈TP

CARs are used to fully capture the effect of an event on share prices, and to accommodate uncertainty over the exact date of the event (Strong 1992).

The test statistics below are used for AR and CAR respectively: ARt : t =

ε t∈TP S ( AR )

∑ (ε where S ( AR) =

t∈EP

∑ε CARTP : t =

(6)

≈ N (0,1),

−

1 ∑εt )2 T − s + 2 t∈EP T − s +1

(7)

jt

t∈TP

S (CAR)

where S(CAR) =

t

≈ N (0,1),

S(AR) T − s +1

(8) (9)

4. CASE STUDIES 4.1 CASE 1: SHANDONG JINTAI GROUP Shandong Jintai (‘Jintai’) was formerly a state owned enterprise and was restructured to be a shareholding company in 1989. The group's principal activities are the research, manufacture and sale of chemical raw material medicines, Chinese and Western medicinal preparations and biological medicines. Other activities include manufacturing and marketing of biological

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products, medical intermediates and medical apparatus, developing and transferring technologies and providing technical services.

The pharmaceutical industry is a high growth industry in China. As at 2003, there were a total of 60 listed companies within the industry. According to China Economic Information Network (CEINet), a leading industry studies expert, the pharmaceutical industry enjoyed a growth of 15.5% from 2001 to 2002, with RMB94.55bn output in 2002. In addition, as we can see in Table 1 below, the industry’s median asset size more than doubled from RMB608mn in 1999 to RMB1391mn in 2003.

Using our definition of distress discussed in section 3.1, between 1999 and 2003, five of the 60 firms were in distress in the sector, including Jintai. Of these five, two are non-SOEs, and three are SOEs. Jintai is a non-SOE firm with zero government shareholding. It is also a small company measured by total assets.

4.1.1 Accounts-based performance As shown in Table 1, 2002 was the first year of Jintai’s distress as measured by our interest cover indicator, with EBITDA/interest ratio massively negative at -9.83%. Jintai’s interest cover had in fact underperformed the industry median in each of the two prior years, though not to a worrying extent, so that the accounts are showing a sharp and decisive decline into distress in 2002.

Insert Table 1 here

Regarding operational performance, the accounts show that Jintai was small for its industry sector, and consistently declining in relative asset size. While its assets stood at 63% of the industry median in 1999, this ratio fell to 54% in 2000 and further to 43% in 2001, the year prior to distress. By the end of 2002 Jintai’s assets were only 27% of the industry median although, as will be shown below, this 2002 decline was predominantly due to the company’s restructuring strategies in response to distress. Both gross margin and EBITDA/assets underperformed the industry median in the two years prior to distress, but here too the sharpest deterioration in performance as indicated by the accounts took place in 2002, with gross margin falling from 53%

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of industry median in 2001 to only 32% in 2002, and the EBITDA/assets ratio being -37.3% in 2002 compared with the 7.9% industry median for that year. These poor 2002 performance measures are due to the virtual disappearance of Jintai’s sales base in that year. Sales in 2002 were only RMB27.6 million, 84% less than the year before, due mainly to the company’s significant restructuring activities in 2002.

The poor operating performance of the years prior to distress was accompanied by signs of weak financial structure as well. Compared to its industry, Jintai was far more reliant on liabilities in general and on debt in particular to fund its activities. This had been the case in both 2000 and 2001, and by 2002 the company was funded 81.1% by liabilities (industry median = 42.0%) and 54.0% by debt (industry median = 26.2%).

This analysis shows that Jintai was exhibiting both operational and financial problems in the years prior to distress. This conclusion is confirmed by news reports that around the time of Jintai’s listing in July 2001, it had come to light8 that the company was starting to become exposed to a variety of issues, such as a high level of bank debts; obsolete technology due to a lack of investment over the years; management devoting excessive efforts in its listing application; and the fact that there were only about 10% potentially realisable accounts receivables of a total of RMB100mn.

The company employed a number of restructuring strategies since 2002, such as operational and managerial restructuring, measures which seem to have a longer term strategic nature without immediate cash flow generating implications (unlike some of the U.K. distressed firms studied in Lai and Sudarsanam 1997). One possible explanation is that, due to the absence of an effective bankruptcy law, distressed firms are not worried about being liquidated when they default on loans. Below we use event study to gain an understanding of market reactions to the company’s announcements, paying particular attention to restructuring related news.

4.1.2 Market reaction to the restructuring strategies of Shandong Jintai Figure 1 shows the company’s raw (unadjusted) stock return, and its raw return minus the contemporaneous return on the equally weighted SZ All A-shares Index. Appendix 2 lists a total

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According to articles published on the official stock exchange website.

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of 13 restructuring related announcements9 made by the company between 2001 and 2003. Of the 13 announcements, four relate to M&A announcements and updates thereon; two relate to asset sales and operational restructuring; three to managerial restructuring; and four to new bank loans or bank loan renewal. Event study results of these announcements are reported in Table 2.

Insert Figure 1 here Insert Appendix 2 here

Jintai started its application for listing in 1993 and was eventually floated on the Shanghai Stock Exchange, eight years later, on July 23 2001. This lengthy process is mainly a result of bureaucracy and the extreme demand for listing status outstripping supply (Jiang et al. 2005). Consistent with other IPOs, the share price recorded a cumulative equally weighted market adjusted return of 8.7% by the 6th day. It then started to drop on the 7th day and the cumulative market adjusted return on the 10th day was -3.6%.

Six months after its listing, the company announced on December 17 2001 that the existing controlling shareholder, Shandong Medical Research, was selling its holding of 26.99% to Xin Hong Ji Group. Jintai had a dispersed shareholding structure with the second largest shareholder holding only 7.13%. Therefore, although Xin Hong Ji Group only bought 26.99% shares in Jintai, it became de facto the controlling shareholder. Xin Hong Ji Group agreed to pay RMB52 million for this transaction, with RMB30 million paid as a first instalment. However before the remaining RMB22 million was paid, the auditor of Xin Hong Ji Group discovered that Jintai was facing severe financial problems (see article published on www.cninfo.com dated April 15 2003). At the time of the transaction, there was no legal requirement for either Shandong Jintai or Xin Hong Ji Group to disclose the details of the transaction. The abnormal share price movement on the announcement of this change in control was -2.51%, though not significantly different from zero.

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There were also seven multiple announcements relating to managerial restructuring, M&A completion, share suspension from the stock exchange and ‘ST’ status, loan renewal and court order of due payments. We excluded these announcements from our event study as we cannot isolate one event form the other.

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This change in control was followed on very quickly by a number of significant further restructuring activities. Three days after the announced change in control a major operational restructuring was announced. This involved Shandong Jintai firstly selling one of its product lines for RMB330000, and also establishing a joint venture with the buyer of the product line. Shandong Jintai transferred fixed assets to this joint venture giving it a controlling 78% share in the operation. Although the market reacted negatively to the announcement on the day with an abnormal movement of -1.65%, the 10-day cumulative abnormal return was +2.71% (although these results are not significant). These transactions were followed shortly by a major management change, the first of many such changes which are more characteristic, as in this case, of non-SOEs than SOEs. Thus on January 7 2002 three managers, including the general manager and chief financial officer, resigned and were replaced. This triggered a large negative share price movement of -9.13% (significant at the 1% level) on the day of the announcement. Further management changes were announced on February 8 2002 when three additional board directors were appointed (accompanied by a non-significant -0.56% abnormal price change) and on March 4 2002 when a new Chairman was elected and deputy general managers appointed (with a non-significant positive abnormal price change of 3.32%). It should be noted that, as disclosed in multiple news announcements, further management changes took place in February 2003 (including appointment of a new general manager) and April 2003 (when the deputy general manager and chief financial officer resigned, with the latter’s duties taken over by the existing general manager).

However these changes were only precursors to the major May 24 2002 restructuring which involved a complex hive-off of significant parts of the business. These, according to Jintai’s 2002 annual report, were triggered by liquidity and working capital constraints at a time when price competition in the pharmaceutical sector was intensifying as a result of the sector being liberalised. Firstly Jintai announced that it was transferring fixed assets from one of its subsidiaries into a newly formed company in which it would have a 20% interest; and secondly it was hiving off its retail business into a new pharmacy retail company in which it would have an 80% interest, with the remaining 20% held by the 80% shareholder in the first announcement. Of particular interest these transactions provide evidence of a distressed non-SOE transferring either complete or partial control of parts of its business without receiving any consideration, cash or

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otherwise, indicative that these asset transfers at times of distress are not limited exclusively to SOEs.

These asset restructurings were followed by a number of leverage-increasing announcements. On June19 2002 Jintai announced board level approval of the decision to raise working capital finance from its bank, and on December 13 2002 it announced assumption of an RMB20 million one-year loan from Jiao Tong Bank. The first announcement was accompanied by a negative abnormal share price movement of -1.51% on the day and the second by an increase of 1.31%, with neither of these significantly different from zero. Jensen (1986) and Wruck (1990) argue that debt provides positive disciplinary role and that using exchange offer announcements, as summarised in Weston et al (2001), empirical studies suggest that the market reacts favourably to companies when they increase leverage. However Tian (2004) documents that, for China, increased leverage increases management entrenchment and perks, concluding from this that debt governance is not at work in China.

In order to examine the overall market impact of the different corporate restructuring strategies, we calculate the average abnormal returns and the cumulative average abnormal returns using the four different categories – M&A, asset sales/operational, managerial and leverage-increasing. The results are reported in Table 210. Among the four debt-related restructuring announcements, two events took place on two consecutive days. To avoid confounding effects, only the first one is included in the calculation of average abnormal returns and cumulative average abnormal returns. Due to the small number of events in each category, the average abnormal return and the cumulative average abnormal return results in Table 2 are best treated as exploratory.

Insert Table 2 here

Table 2 shows that none of the average abnormal return on the day of announcement (AAR0) for the four types of restructuring announcements is statistically significant. Only managerial restructuring announcements have an economically significant AAR0 of –2.91%. The signs of 10

As a robustness check, consistent with the literature, such as Krivin et al. (2003), we exclude the first 5 returns from the estimation period to eliminate any stock price reaction immediately following the IPO and the results are identical. In addition, we repeat the analysis using the market adjusted model and also find conclusions do not change.

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11-day cumulative average abnormal returns (CAAR+/-5) are consistent with AAR0, with the most economically significant CAAR+/-5 being –2.62% for asset sales. According to the signs of CAAR+/-5, the market reacted negatively to all four types of announcements. Different event windows produce results of opposite signs, except for managerial restructuring announcements. However neither the cumulative average abnormal returns nor the AAR0 are significant statistically.

The event study results suggest that the company’s M&A strategy is not perceived by the market as an effective restructuring strategy. Its frequent use of asset and operational restructuring strategies did not receive significant market reaction either. During the company’s distress period, we also observed frequent senior management departures, one of which was perceived by the market strongly unfavourably. We will further analyse these results in section 5.

4.2 CASE STUDY TWO: SICHUAN JOINT-WIT MEDICAL Sichuan Joint-Wit Medical and Pharmaceutical Industry Company Limited (‘Sichuan’), formerly known as Sichuan No. 1 Textile Stock Company Limited, was an SOE with 65.6% state-owned shares immediately after listing on the Shenzhen Stock Exchange in June 1998. The Group's principal activities were the manufacture and sale of yarn, thread, base cloth, dyed cloth, knitwear, garments, beddings, adornments, machinery equipment, apparatus, meters and spare parts. Other activities included import and export trade, purchase of raw cotton and manufacture of chemical fibre yarn. The Group’s main products were cotton cloth and cotton yarn. The textile industry included five listed companies, all under the control of the state. In addition, there was a large number of non-listed non-state-owned small to medium size companies within the sector. The industry has been growing rapidly and the increased production and sales were a manifestation of brisk consumer spending and growing exports. As Table 3 shows, among the five listed companies, the median industry book value assets increased year-on-year from RMB608 million in 1999 to RMB1.39 billion in 2003. Sichuan was the smallest listed company in the industry in 1999.

4.2.1 Accounts-based performance

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Table 3 shows that the first year of the company’s distress (i.e. the year in which the ratio of EBITDA to interest expense fell below 1) was 2001. The Table displays key performance indicators for the two years prior to distress and the two subsequent years.

Insert Table 3 here

In terms of operating performance, Sichuan’s EBITDA/assets ratio was similar to its industry median prior to distress, but became negative in 2001 and 2002. However the 1999 gross margin of 11.8% was already well below the industry median of 18.7%, and this shortfall grew consistently in subsequent years. In addition the company’s capital spending/assets ratio was already lagging well behind that of the industry median in 1999. This poor operational performance was all the while accompanied by rapid growth in numbers of employees from 4350 in 1999 to 9847 by 2001. As a result sales per employee declined from RMB580000 in 1999 to RMB370000 by 2001, well below that of the industry median, even in this sector which comprised only SOEs.

Turning to Sichuan’s financial performance, while the ratio of total liabilities/assets was above the industry median and growing each year, neither the proportion of current to total liabilities nor the debt/asset ratio were worrying when compared to the industry median, either before or after entering distress. These points, taken together with the poor operational performance highlighted above, point to economic inefficiencies being the main cause of distress for this SOE rather than financial problems such as excessive debt. In addition it is evident that a number of operational indicators were already showing that Sichuan’s performance fell well below the industry median two years prior to entering distress.

As will be shown in more detail in the next section, in 2000, one year prior to distress, the government attempted a number of restructuring strategies including transferring state-owned shares from an asset management SOE to a textile SOE which supposedly had industry-specific management expertise but in vain. The new SOE controlling shareholder was not able to turn the performance around either. In December 2002 the company had to severely cut back operations due to deteriorating cash flow problems. Eventually, it had to lay off its extremely large labour force, the main source of inefficiency, and initiate its exit from the labour-intensive textile

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industry in 2003. While the total number of employees was 6560 in 2002, this figure dropped sharply to only 709 in 2003 due to large-scale redundancies.

4.2.2 Market reaction to the restructuring strategies of Sichuan Joint-WIT Figure 2 shows the company’s raw (unadjusted) stock return, and its raw return minus the contemporaneous return on the equally weighted SH All A-shares Index. Thirteen restructuring related announcements made by the company between 2000 and 2003 were collected and these are presented in Appendix 3. Although in 2003 the company’s interest cover was back to a healthy 9.2 times, higher than the industry median of 8.6 times, the year 2003 is included in our analysis as it was during this year that the company completed a complex strategic asset restructuring process.

Insert Figure 2 here Insert Appendix 3 here

Among the 13 announcements, four relate to M&A via shares being transferred to a new controlling owner and without payments; one relates to M&A with payment; two to asset sales and operations restructuring; and one to managerial restructuring. Of the 13 events, five took place either during the period when the company share price was capped (due to “special treatment” status) or suspended, and therefore we are only able to carry out event study analysis on eight events, results of which are presented in Table 4.

Year 2000 was the first year that Sichuan embarked on its first major restructuring strategy. This was the plan, announced on January 11 2000, for the controlling state shareholder, Chendu Asset Management, to dispose of its 52% shareholding. While 8.3% of this would be sold to two Haikou (a coastal city) companies for cash, the remaining 43.7% was to be transferred without any consideration to another SOE. This amounted, therefore, to the effective acquisition of Sichuan by another SOE, with a view to its management being transferred from an all-purpose asset management company to a sector specialist company. However the abnormal share price movement on the day of the announcement was minus 2.32% which, while not significantly different from zero, was at the very least indicative of the market’s indifferent view of ownership remaining with the state in a transaction in which the acquirer was not required to make any

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payment. This form of change of control is characteristic of SOEs, in contrast to the more conventional sale of shares for payment generally found in non-SOEs.11 This proposed transfer was, however, not completed. Then on September 18 2001, the controlling shareholder, Chendu Asset Management announced it was to transfer 48% of its holding to another textile SOE company which would be de facto the controlling shareholder. This latter de facto M&A without payment transfer was eventually approved by the central government by July 2002.

As can be seen in Figure 2, from early 2002 to September 2003, the stock’s cumulative abnormal returns started to deteriorate. It seemed the new SOE owner was not able to transform the company. On January 28 2003, the company announced that the municipal government would lead the company’s restructuring, including its relocation and employee redundancies. The market embraced this announcement with strong positive response – the event day abnormal return was a positive 5.26%. The government’s involvement in employee redundancy meant that it would subsidise the company’s obligation to settle redundancy payments in order to main social stability. Then on May 23 2003 the controlling state shareholder signed an agreement to sell its 43.7% holding to a pharmaceutical company for RMB167 million. The purchaser would become the controlling shareholder once the deal was completed. This announcement was accompanied by a 3.76% abnormal return on the day. However shortly afterwards on July 10 2003 it was announced that the entire shareholding of the SOE controlling shareholder had been frozen by the court in June 2003 for one year because of overdue debts owed to Chendu Industrial Development Ltd. The abnormal return on this announcement was an economically although not statistically significant -3.87%, indicative of the market’s disappointment at the cancellation of this deal.12 As a result of the court order, cancellation of the share sale agreement to the pharmaceutical company was announced on September 15 2003.

On August 21 2003 the company announced that it would sell its textile business assts net of related debt to a textile business for RMB26.8 billion, with RMB13.2 billion of redundancy payments deducted, leaving Sichuan with a net cash inflow of RMB13.6 billion. Sichuan would then achieve the transformation from being a textile to a pharmaceutical company which had

11

Although the Shandong Jintai case above does include changes in ownership of subsidiaries achieved via asset transfers and without any payments changing hands. 12 This price change has not been included in our summary tables as it was not a restructuring event.

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previously been obstructed by the court order referred to above, by using part of its newly-found cash to purchase an 81% holding in a pharmaceutical company for RMB0.12 billion. These transactions were indeed completed on December 31 2003. It should be noted that between August 28 2003 and December 19 2003 the stock was suspended from the exchange due to continued deterioration in profitability, and the stock price continued to plunge from the first day of relisting, December 23 2003, up until the end of the year.

The overall share price movements by restructuring category are summarised in Table 4. This shows the event day abnormal return for two of the M&A without payment announcements in 2001 were positive but were not significant either economically or statistically. However event day return for the follow-up announcement in 2002 was negative. The average abnormal return of the four announcements on day 0 is negative but again not statistically or economically significant, and its CAAR10 is –-3.32% but not significant. On average the market reacted negatively to M&A without payment announcements.

Insert Table 4 here

Although there were five asset sales and operations restructuring related announcements, three of these took place during the share’s suspension period or when the share price movement was capped. Table 4, therefore, shows only the remaining two announcements. The average abnormal return on announcement day was 2.73% but this was not statistically significantly different from zero. The M&A with payment announcement on May 23 2003 as part of the company’s 2003 strategic restructuring process resulted in a AR0 of 3.76%, and CAR(-2, +2) of 10.90%, both significant at the 1% level. This M&A transaction was not completed and on September 15 2003 the company announced the cancellation of the intended M&A with payment transaction. As the cancellation announcement was made during the stock’s suspension period, event study analysis could not be carried out. Finally, the market reacted negatively to announcement relate to the managerial restructuring announcement. These results are in general consistent with those of the first case study, Shandong Jintai. In addition, this case provides an interesting comparison of market reaction between M&A with and M&A without payment announcements.

In this case, the market reacted negatively to M&A without payment

announcements but positively and significantly to M&A with payment announcement.

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5. DISCUSSION The two cases we present here highlight the role of government versus non-government ownership in distress resolution as an important corporate variable determining the success of various restructuring methods employed for recovery. First, mergers and acquisitions are valueenhancing when a payment is involved and ownership is transferred from state to non-state shareholders. However M&A transactions between state companies and without payment being made is not perceived by the market as value-enhancing.

M&A was employed by both Shandong Jintai and Sichuan Joint-Wit as the major strategy for recovery. In the SOE Sichuan case, M&A without payment was first employed with state shares changing hands between SOEs. When this transaction failed to turn the company’s performance around. Sichuan Joint-Wit then announced an intended M&A with payment transaction. While the average abnormal return on the relevant M&A without payment announcements was -0.3%, the abnormal return on the subsequent M&A with payment announcement, which would have entailed the privatisation of state-owned shares, was a significantly positive 3.8%. Shandong Jintai, the non-SOE, engaged in a number of M&A for payment transactions. In contrast to the significantly positive market reaction to Sichuan Joint-Wit’s M&A with payment announcement, the average abnormal return for Shandong Jintai was a non-significant -0.2%. This suggests that it is the transfer of control from SOE to non-SOE that is perceived most positively by the market as a successful restructuring strategy.

In the SOE Sichuan Joint-Wit case, managerial disciplinary events are not frequently observed. There is only one managerial restructuring announcement following the M&A with payment announcement.

On the contrary, in the non-SOE Shandong Jintai case, as a distressed

commercial company, frequent announcements of departures (both forced and voluntary) of senior management are observed. The market’s reaction to these announcements was mixed. Events entailing the appointment of additional directors or general managers were accompanied by positive, although not statistically significant, price reactions. However the announcement of the resignation and replacement of key appointments, including the company’s general manager and its chief financial officer, triggered a significantly negative share price change. This negative

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result is not consistent with evidence from developed economies (Dennis and Dennis 1995; Dherment-Ferere and Renneboog 2002). One possible explanation is that this type of announcement sends a hybrid signal to the market. Thus, Roland and Sekkat (2000) argue that in a socialist economy, due to asymmetric information about managerial skills, good managers have little incentive to out-perform others. Following this line of argument, the act of replacing incumbent management does not bring about the desired result of better performance for SOE. Future investigation using large scale international data could provide better understanding on this issue.

Restructuring strategies entailing mere transfers of assets or shareholdings, do not have any significant impact on firm values. Such strategies, which were implemented in both these Chinese firms, do not have immediate cash flow-generating implications. This contrasts with the cashgenerating strategies observed in developed economies (Asquith et al. 1994; Lai and Sudarsanam 1997). Chinese firms do not face the same threat of bankruptcy as firms in say the U.S. and the U.K. For example, during the first year of its distress, Shandong Jintai’s management still had the time to experiment with new operating strategies despite the adverse circumstances, further demonstrating the lack of threat from potential bankruptcy or liquidation. The management was able to conduct such experiments by selling assets and using the proceeds to invest in other activities, rather than meeting overdue debt payments.

Both companies frequently employed mergers and asset sales in their effort to restructure. Given that the nature of distress in China is predominantly economic, as documented in Kam et al. (2005), this is perhaps not a surprising result. As a result of the difficulties in officially liquidating economically unviable firms in the Chinese context due to the lack of effective bankruptcy laws, these observed mergers and asset sales are perhaps a beneficial outcome in terms of improved use of resources. Using U.S. data, Kahl (2001) also argues that M&A are used in re-allocating assets to more efficient uses and that, although Chapter 11 tends to maintain inefficient firms alive, these distressed firms are not tolerated for long by the market. In addition, Weston et al. (2001) argue that divestitures perform vital economic functions by moving resources from less valued to higher valued uses and therefore contribute to the resource mobility essential to the effective operation of an enterprise economy.

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We also observe a small number of debt related restructuring announcements in the non-SOE Shandong Jintai case. In this case the distressed debtor renews existing or obtains further loans. These events differ from those generally found in the existing literature which documents more active creditor participation in financial restructuring such as debt for equity swaps, debt forgiveness and write-downs. This is perhaps not so surprising given the lack of creditor protection in the existing formal bankruptcy process in China. In addition, the event study results show that the market reacts negatively to the company’s announcements on renewing or increasing leverage. This is contrary to the debt governance theory advocated by Jensen (1986) and Wruck (1990). There are two potential explanations for these results. Firstly because, as argued by Tian (2004), debt governance is not at work in the Chinese institutional context, increased leverage may merely increase management entrenchment and perks. Secondly, the distressed firm’s attempt to renew existing or obtain further debt may be signaling to the market its poor performance.

6. CONCLUSIONS The two case studies provide an information-rich environment to understand how Chinese distressed firms restructure and how these restructuring strategies impact shareholder wealth. Asset restructuring, including M&A with and without payment, asset sales, debt and managerial restructuring strategies are employed by both firms. Equity restructuring is not observed in these two cases. This likely because the two Chinese stock exchanges impose strict rules on firms wishing to issue further equity, making it very difficult for non-profitable firms to issue additional equity.

Both firms frequently sell assets under distress. The motivation for selling assets does not seem to be associated with enabling the firms to meet overdue debt obligations as there is no evidence of significant debt repayments. Instead, it is associated with their severe liquidity constraints and with providing liquidity for working capital requirements and, in the Jintai case, for management to experiment with new operational strategies.

M&A is employed successfully by the SOE firm. The market’s reaction suggests that market participants view privatisation favourably and that a continuing government role in the distress

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resolution process is unwelcome. In addition, market’s indifference to the non-SOE’s M&A with payment announcement suggests that takeover is not perceived favourably by the market as a turnaround strategy.

This research has raised a number of important issues throwing light on distressed firm restructuring in a context where substantial state ownership persists despite on-going market liberalization and where formal insolvency procedures are absent. Further investigation is needed to understand the motivations and mechanisms for distressed firms in such an environment to transfer their shares and assets without payment, and for the complex joint venture structures that often result from this process. In addition, the reasons for the negative market impact of certain managerial and debt restructuring strategies need further examination. Finally a larger-scale study could test whether distressed SOE acquisitions by non-SOEs are systematically viewed as more value-enhancing than other M&A strategies.

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APPENDICES Appendix 1 A translation of some of , Shenzhen Stock Exchange13, effective 12th March 2002 1.

2.

3.

4. 5. 6. 7.

8. 9.

10. 11. 12. 13. 14.

13

Purchase/sell assets and debt restructuring. a. General information of the transaction, including names of both parties, nature of transaction (sell/buy/debt restructuring), prices, agreement date and transaction dates, if the transaction is between related parties. b. Board of directors’ decision, voting details, etc. Also, if this transaction needs approval from certain government bodies, if agreement from creditors is required, if any agreement from a third party is required. c. List all necessary procedures for approval and other requirements and potential barriers for the intended transaction. d. Information about other parties. If the transaction involves the forgiveness of debts, information about the creditor, its relationship with the company. e. Debt restructuring here only refers to non-cash arrangements for debt reduction, interest payment suspension or reduction, change of covenants, and debt forgiveness. f. If the transaction is between related parties, see relevant legal provision for announcements. Transactions between related parties a. Generation introduction: agreement date, venue, relationship between parties, shareholder meeting and board of directors meeting’s decision and voting details, if such transaction requires approvals, etc. b. Details about the transaction, etc. Distribute and transfer equity shares (with or without payments) a. Meeting time and details of the shareholder meeting when the notion to issue further equity shares, or transfer equity shares has been passed. b. Registration of new shares/shareholders. Shareholders’ meeting notice The resolution of shareholders meetings Make external investment (including entrusting) Provide guarantees for others a. General information. b. Information about the guaranteed company. c. Content of the guarantee. d. Comments from the board of directors, reason for such guarantee, etc. Change the purpose of funds raised Unusual share price movements a. Introduction – state that there are observed share price abnormal movements, the reason for such movement, or for the suspension of its listing. b. After conformation with major shareholders and management team, provide reasonable explanation for such observation. If no known cause to the company for such movements, issue standard statement. Clarification Major litigation and court order Receiving permission to issue additional equity Change share name abbreviation Independent director nomination

The Shanghai exchange has similar regulations.

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Appendix 2 Event calendar for Shandong Jintai These 13 announcements were collected from the Shanghai Stock Exchange’s official websites: www.cninfo.com.cn and www.cnlist.com.cn; and according to the company’s annual reports. Column 1 gives the date of the announcements, if the share was not traded on the announcement date, the returns are calculated using the first trading day following the announcement; Column 2 gives the restructuring type; Column 3 presents the summary of the announcements; Column 4 presents the share’s unadjusted day return (log return); Column 5 presents the market’s day return (log return of Shanghai SE A Index); Column 6 presents the company’s daily value gain/loss by using the absolute difference in opening and closing prices multiply by the total number of tradable shares. Dates

Restructuring type

Announcement

17/12/01

M&A announcement

20/12/01

Asset sales/ investment

25/12/01

M&A news follow-up

07/01/02

Managerial restructuring

02/02/02

M&A follow-up

08/02/02

Managerial restructuring Managerial restructuring

Controlling shareholder (Shandong Medical Research Centre) selling its holding of 26.99% shares to Xin Hong Ji Group. The company was selling one product line for RMB0.33m (net book value 0.22m), (in the same announcement; also using some fixed assets as investment to set up a joint venture with the buyer, with the fixed assets the company would hold 78% of the JV) Further announcement about the controlling shareholder’s transfer of its 26.99% shares. Three directors resigned and candidates elected. GM and CFO resigned and appointed new persons. Standard follow-up announcement about the M&A on 17 Dec 01. Shareholders’ meeting approved adding 3 directors to the board. Elected chairman for the board, secretary of board resigned, deputy GMs appointed etc. Board meeting approved: 1. Use the fixed assets of one of its subsidiaries as 20% holding to form a new company with another company. 2. Split retail business from the company to form a new pharmacy retail company. Jin Tai will hold 80%, the rest to be held by the same partner as in Motion 1 above. Board meeting approved the motion to borrow additional loan (working capital loan, max 2 years) from its bank - to be approved by shareholders’ meeting.

04/03/02

24/05/02

Investment/ operational restructuring

19/06/02

Increase leverage (new bank loan)

Firm day return

Market day return

Daily value gain/loss (RMB mn)

-3.12%

-0.61%

-29.17

-4.17%

-2.53%

-37.99

-0.08%

+0.30%

-0.68

-10.96%

-1.83%

-92.26

+3.21%

+1.70%

25.78

+1.01%

+1.01%

8.14

+4.93%

+1.62%

39.34

-1.97%

-1.42%

-16.28

-2.60%

-1.09%

-19.67

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27/07/02

M&A follow-up

13/12/02

Increase leverage (new bank loan)

14/12/02

Debt related (providing guarantee)

14/08/03

Increase leverage (renew loan)

Standard follow-up announcement about the M&A on 17 Dec 01. Took a 1-year loan of RMB20m on 11/12/02, from Jiao Tong Bank; external guarantee provided by Wu Han Dao Bo Company. Provided guarantee for Wu Han Dao Bo Company for a 15-months RMB24m loan; this brings the company’s aggregate guarantee to RMB57.66m. The RMB20m loan was due on 08/08/03. Two new loans were taken from the same bank to pay st back the existing loan. 1 loan is nd RMB10m for two years, 2 loan is RMB10m for three years. rd Guarantee provided by its 3 largest shareholder.

+1.20%

+0.49%

9.50

+2.31%

+0.92%

+14.25

+0.87%

+0.82%

+5.43

-1.13%

-0.68%

-4.07

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Appendix 3 Event calendar for Sichuan Joint-WIT These 13 restructuring announcements were collected from the Shenzhen Stock Exchange’s official websites: www.cninfo.com.cn and www.cnlist.com.cn; and was cross-checked with another popular website for financial information www.163.com. Column 1 gives the date of the announcements, if the share was not traded on the announcement date, returns are calculated using the first trading day following the announcement; Column 2 gives the restructuring type; Column 3 presents the summary of the announcements; Column 4 presents the share’s unadjusted day return (log return); Column 5 presents the market’s day return (log return of Shenzhen A Index); Column 6 presents the company’s daily value gain/loss by using the absolute difference in opening and closing prices multiply by the total number of tradable shares. Dates

Restructurin Announcement g type

Controlling shareholder, Chendu Asset Management Co intend to sell 1.53% and 6.76% holding to two Haikou companies at RMB2.2 per share. In addition, it intended to transfer its holding of 43.7% State shares to a textile group (transaction not completed) 30/12/2000 Operations Restructuring two subsidiaries, using restructuring both subsidiaries' operating assets as (asset investment in the new JV, holding restructuring) 70.56% and 82.63%, respectively. 18/09/2001 M&A without Controlling shareholder Chendu Asset payment Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Sichuan Municipal Government 18/10/2001 M&A without Controlling shareholder Chendu Asset payment Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Finance Ministry. 06/07/2002 M&A without Controlling shareholder Chendu Asset payment Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Finance Ministry. 28/01/2003 Operational Informed by the controlling restructuring shareholder, the municipal government will lead the company's restructuring, relocation and employee redundancy. 23/05/2003 M&A with Company was informed that the payment controlling State shareholder signed agreement on 22/05/03 to sell 43.07% of its holding to a pharmaceutical company for RMB167mn. After the transaction the buyer would become the controlling shareholder.

Firm day return

Market day return

Daily value gain/loss (RMB mn)

-6.49%

-4.17%

-21.7

1.60%

1.40%

9.1

1.16%

0.80%

5.6

-0.71%

-1.76%

-2.8

0.46%

0.88%

1.75

5.50%

0.24%

16.8

4.83%

1.07%

13.3

11/01/2000 M&A without payment

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28/06/2003 Managerial restructuring

According to the 2003 AR, on 27-062003, new Chairman of the board, CEO, CFO and GM etc has been elected. The previous ones left the position due to the M&A. The news was announced on 28th June 2003. 21/08/2003 Asset sales Company intended to sell all its assets relating to textile business and buy controlling shareholding of a pharmaceutical company (same news about selling on 27/08/03). Also the company announced its Q2 report (loss). 27/08/2003 Operations Company sold its total assets and restructuring debts relating to textile business (asset valued at RMB26.8bn, deducting restructuring) redundancy fee of RMB13.2bn, and therefore transaction price at RMB13.6bn. Buyer pay cash. The company then bought 81% holding of a pharmaceutical company at the price of RMB0.12bn from a related company. The transactions were completed on 31st December 2003. 15/09/2003 M&A Agreement reached to cancel the cancellation M&A transaction announced on 23/05/03. 30/09/2003 Debt The company's accounts payable to restructuring another textile company amounting to RMB43mn was transferred to another company.

-1.36%

-0.77%

Share price capped since th 20 August 2003.

Share price capped since th 20 August 2003. Share suspended

Share suspended

22/12/2003 Restructuring announced the relisting, company's follow-up major asset sales and purchase report Share and auditing on these transactions. suspended

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-3.5

TABLES Table 1 Accounting information for Shandong Jintai 1999-2003 This table presents the key accounting data for Shandong Jintai and its industry (4-digit SIC classification), in terms of operating and financial performance, liquidity, investment and size, during 1999 to 2003. t=-1, 0, and +1 denotes prior to, first and second year of coverage shortfall, respectively. For detailed discussion on each empirical proxy see Kam et al (2005). t=-3 (Y1999) Selection criterion Interest cover Variables Operating performance EBITDA/asset Gross Profit Margin EBITDA/sales Sales/asset

Firm #N/A

t=-2 (Y2000)

Industry median 7.327

Firm Industry median 3.988 7.632

t=-1 (Y2001)

t=0 (Y2002)

Firm Industry median 3.244 6.889

Firm Industry median -9.830 6.962

t=+1 (Y2003) Firm Industry median -5.078 5.991

#N/A 0.296 #N/A 0.452

0.096 0.417 0.243 0.401

0.073 0.296 0.191 0.381

0.093 0.457 0.220 0.421

0.064 0.222 0.159 0.401

0.078 0.418 0.213 0.392

-0.373 0.120 -4.275 0.087

0.079 0.378 0.195 0.428

-0.254 0.265 -5.832 0.044

0.084 0.359 0.180 0.508

Financial performance Interest Expense/assets Current liab/total liab Total liab/asset Total debt/asset Accounts payable/total liab AccountsPayable/Sales

0.019 0.811 0.500 0.327 0.174 0.193

0.013 0.905 0.487 0.244 0.149 0.144

0.018 0.723 0.539 0.407 0.115 0.163

0.012 0.915 0.421 0.223 0.132 0.130

0.020 0.866 0.522 0.370 0.116 0.151

0.011 0.941 0.377 0.250 0.134 0.129

0.038 1.000 0.811 0.540 0.220 2.040

0.011 0.949 0.420 0.262 0.134 0.129

0.050 0.925 1.107 0.675 0.015 0.387

0.014 0.892 0.433 0.277 0.135 0.127

Liquidity Current asset/current liab

1.415

1.201

1.075

1.564

1.059

1.500

0.426

1.345

0.281

1.244

0.038

0.022

0.045

0.007

0.064

0.032

0.067

0.002

0.066

0.195 526246.9 1353

0.206 541153.9 786 162.2 425.3 187.0

0.181 546587.6 1344

0.252 629926.5 680 171.6 428.4 195.3

0.229 657347.4 1456

0.031 349653.8 904 27.6 316.1 44.9

0.285 669646.0 1540

#N/A #N/A #N/A 10.5 240.81 -31.72

0.340 720334.9 1669

Investment Capex/assets

#N/A

Size Sales/employee (RMBmn) Asset/employee (RMB) Employees Sales (RMBmn) Assets (RMBmn) Equity (RMBmn)

#N/A #N/A #N/A 172.7 382.5 181.9

Other Accounts receivables/Sales Accounts receivables (days)

0.658 #N/A

608.4

0.260 172.8

786.8

0.211 82.2

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31

988.6

0.383 305.3

1184.8

0.936 349.9

1391.7

Table 2 Market reactions to different types of restructuring in the Shandong Jintai case This table presents the event study results for the announcements made by Shandong Jintai to reverse its performance decline and financial distress, as listed in Appendix 2. Using market model in event study methodology, we calculate the abnormal return on day 0 (AR0), cumulative abnormal return for different width of event windows. In addition, for each restructuring type, AAR0 denotes average abnormal return on day 0, CAAR+1 denotes cumulative average abnormal return from day 0 to +1; CAAR+/- 2 denotes cumulative average abnormal return from day –2 to day +2; and CAAR+/- 5 denotes cumulative average abnormal return from day –5 to day +5. M&A with payment

No of events

AR0 -2.51% -0.38% 1.51% 0.70%

4

AAR0 -0.17%

CAAR(0,+1) -0.38%

CAAR(-2,+2) 3.29%

CAAR(-5,+5) -0.54%

AR0

CAR(-2,+2) 1.17% -0.50%

CAR(-5,+5) 2.71% -7.80%

20/12/2001 24/05/2002

-1.65% -0.20%

CAR(0,+1) 0.17% 0.50%

2

AAR0 -1.10%

CAAR(0,+1) 0.24%

CAAR(-2,+2) 3.40%

CAAR(-5,+5) -2.62%

AR0

CAR(-2,+2) -5.94% -1.41% 3.18%

CAR(-5,+5) -3.12% 2.06% 1.30%

Managerial restructuring

No of events

07/01/2002 08/02/2002 04/03/2002

-9.13%*** -0.56% 3.32%

CAR(0,+1) -5.58% -0.83% 6.12%

3

AAR0 -2.91%

CAAR(0,+1) -1.79%

CAAR(-2,+2) -1.98%

CAAR(-5,+5) -0.52%

19/06/2002 13/12/2002 14/08/2003

AR0 -1.51% 1.39% -0.45%

CAR(0,+1) -1.43% 1.44% -1.40%

CAR(-2,+2) 1.73% 1.97% -1.45%

CAR(-5,+5) -0.21% -1.58% -1.89%

3

AAR0 -0.19%

CAAR(0,+1) -0.47%

CAAR(-2,+2) 0.75%

CAAR(-5,+5) -1.23%

Debt restructuring

No of events

CAR(-5,+5) -1.50% -0.85% 2.70% -2.98%

17/12/2001 25/12/2001 02/02/2002 27/07/2002

Asset sales/operational

No of events

CAR(-2,+2) 2.37% 1.99% 7.92% 0.89%

CAR(0,+1) -0.85% -0.85% 0.20% -0.01%

* Significant at the 10% level ** Significant at the 5% level ***Significant at the 1% level

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32

Table 3 Accounting information for Sichuan Joint-WIT 1999-2003 This table presents the key accounting data for Sichuan Joint-WIT and its industry (4-digit SIC classification), in terms of operating and financial performance, liquidity, investment and size, during 1999 to 2003. t=-1, 0, and +1 denotes prior to, first and second year of coverage shortfall, respectively. For detailed discussion on each empirical proxy see Kam et al (2005). t=-2 (Y1999) Selection criterion Interest cover Variables Operating performance EBITDA/asset Gross Profit Margin EBITDA/sales Sales/asset

t=-1 (Y2000)

Firm Industry median 15.918 17.287

t=0 (Y2001)

Firm Industry median 14.481 20.600

t=+1 (Y2002)

Firm Industry median -5.632 9.971

t=+2 (Y2003)

Firm Industry median -13.096 8.155

Firm Industry median 9.236 8.637

0.117 0.118 0.192 0.608

0.133 0.187 0.199 0.703

0.108 0.141 0.135 0.797

0.092 0.208 0.221 0.418

-0.082 0.005 -0.101 0.814

0.077 0.184 0.176 0.433

-0.078 -0.038 -0.095 0.819

0.084 0.195 0.204 0.434

0.200 0.060 0.143 1.396

0.069 0.165 0.145 0.481

Financial performance Interest Expense/assets Current liab/total liab Total liab/asset Total debt/asset Accounts payable/total liab AccountsPayable/Sales

0.007 0.997 0.441 0.096 0.276 0.201

0.008 0.834 0.354 0.239 0.061 0.036

0.007 0.932 0.551 0.197 0.194 0.134

0.004 0.847 0.396 0.261 0.081 0.085

0.015 0.630 0.630 0.213 0.172 0.133

0.008 0.643 0.430 0.294 0.117 0.094

0.006 0.699 0.717 0.199 0.152 0.133

0.010 0.796 0.449 0.340 0.048 0.049

0.022 1.000 0.256 0.026 0.092 0.017

0.008 0.907 0.548 0.374 0.147 0.135

Liquidity Current asset/current liab

1.101

2.376

0.546

1.591

0.624

1.662

0.318

1.045

2.327

1.156

Investment Capex/assets

0.002

0.052

0.014

0.119

0.007

0.094

0.016

0.069

0.013

0.070

Size Sales/employee (RMBmn) Asset/employee (RMB) Employees Sales (RMBmn) Assets (RMBmn) Equity (RMBmn)

0.058 94983.7 4350 251.2 413.2 230.9

0.109 194905.5 3680

0.049 61737.0 8038 395.4 496.2 222.8

0.106 236837.4 3586

0.037 45826.7 9847 367.3 451.3 160.4

0.116 252112.7 3722

0.048 58900.8 6560 316.5 386.4 104.1

0.136 303226.3 3727

0.371 266163.6 709.00 263.4 188.71 114.84

0.184 348226.1 3021

Other Accounts receivables/Sales Accounts receivables (days)

0.456 #N/A

608.4

0.033 58.1

786.8

0.034 12.4

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33

988.6

0.016 9.8

1184.8

0.164 32.9

1391.7

Table 4 Market reactions to different types of restructuring in the Sichuan Joint-WIT case This table presents the event study results for eight announcements made by Sichuan Joint-WIT to reverse its performance decline and financial distress, as listed in Appendix 3. Using market model in event study methodology, we calculate the abnormal return on day 0 (AR0), cumulative abnormal return for different width of event windows. In addition, for each restructuring type, AAR0 denotes average abnormal return on day 0, CAAR+1 denotes cumulative average abnormal return from day 0 to +1; CAAR+/- 2 denotes cumulative average abnormal return from day –2 to day +2; and CAAR+/- 5 denotes cumulative average abnormal return from day –5 to day +5. M&A with payment

No of events

AR0 23/05/2003

3.76%*

CAR(0,+1) 4.21%

1

AAR0 3.76%*

CAAR(0,+1) 4.21%

CAAR(-2,+2) 10.9%***

CAAR(-5,+5) 10.73%

AR0

CAR(-2,+2) 0.49% 8.77%*

CAR(-5,+5) 3.22% 6.18%

Asset sales/operational

No of events

No of events

CAR(-5,+5) 10.73%

30/12/2000 28/01/2003

0.20% 5.26%***

CAR(0,+1) -0.03% 7.20%***

2

AAR0 2.73%

CAAR(0,+1) 3.58%

CAAR(-2,+2) 4.63%

CAAR(-5,+5) 4.70%

AR0

M&A without payment

No of events Managerial restructuring

CAR(-2,+2) 10.90%***

11/01/2000 18/09/2001 18/10/2001 06/07/2002

-2.32% 0.36% 1.05% -0.42%

CAR(0,+1) -0.60% -1.04% 0.21% -0.78%

CAR(-2,+2) 0.98% 1.04% -1.62% 1.31%

CAR(-5,+5) -6.52% -9.24% 3.94% -1.09%

4

AAR0 -0.33%

CAAR(0,+1) -0.20%

CAAR(-2,+2) 0.03%

CAAR(-5,+5) -3.32%

28/06/2003

AR0 -0.60%

CAR(0,+1) -0.28%

CAR(-2,+2) -0.90%

CAR(-5,+5) -4.54%

1

AAR0 -0.60%

CAAR(0,+1) -0.28%

CAAR(-2,+2) -0.90%

CAAR(-5,+5) -4.54%

* Significant at the 10% level ** Significant at the 5% level ***Significant at the 1% level

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34

Figure 1 Cumulative returns of Shandong Jintai 50%

IPO performance

Jintai return adjusted by equally weighted market index

-50% Announcement of takeover Asset sales/investment M&A follow-up Departure of senior management

-100% Election of new board chairman and members New loan transaction with its bank

Forming JV using existing subsidiaries

Jintai raw return

-150% Board approves additional borrowing for working capital

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35

24/12/2003

24/11/2003

24/10/2003

24/09/2003

24/08/2003

24/07/2003

24/06/2003

24/05/2003

24/04/2003

24/03/2003

24/02/2003

24/01/2003

24/12/2002

24/11/2002

24/10/2002

24/09/2002

24/08/2002

24/07/2002

24/06/2002

24/05/2002

24/04/2002

24/03/2002

24/02/2002

24/01/2002

24/12/2001

24/11/2001

24/10/2001

24/09/2001

24/08/2001

-200% 24/07/2001

Cumulative returns (%)

0%

Figure 2 Cumulative returns for Sichuan Joint-WIT

Asset restructuring: using the the operating assets of two nonperforming subsidiaries to set up JVs with 2 other companies

80%

M&A without payment by Chendu Asset Management Co to a textile SOE

Controlling shareholder Chendu AMC intended to transfer 43.7% holding to a textile SOE and sell 8.29% holding to two other companies. Transactions not completed.

60%

M&A without payment plan approved by the Financial Ministry With the approval of the Finance Ministry, the controlling shareholder Chendu AMC transferred 43.7% holding to a textile SOE

Cumulative return (%)

40%

Announced that Chendu Mulicipal government would lead the restructuring and employee redundancy process

IPO performance

Intended selling by controlling shareholder to a pharmaceutical company. Transaction cancelled 3 months later

20%

0%

-20%

-40%

Sichuan JointWIT return adjusted by equally weighted market index

Sichuan Joint-WIT raw return

Announced major asset restructuring plans

-60% 16/06/1998 16/11/1998 16/04/1999

16/09/1999 16/02/2000 16/07/2000 16/12/2000 16/05/2001 16/10/2001 16/03/2002 16/08/2002 16/01/2003 16/06/2003

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36

16/11/2003