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Abstract
How intense is market competition in the Chinese economy? We extend to China, the literature that measures the intensity of market competition in terms of the persistence of firm profitability from year to year. The fundamental notion is that intense competition will quickly evaporate any short run quasi-rents enjoyed by any company, and force each to revert to its own ‘normal’ level of profitability, as determined by its command over various strategic resources. We examine the extent to which deviations from their expected values of profitability tend to be corrected among quoted companies in China. Our estimates, based on Chinese listed companies over the 11-year period to 2005, find that the rate of mean reversion in profitability is 55%. This suggests an intensely competitive market. We also find that the state owned enterprises (SOEs) have a higher propensity to revert to their expected profitability, at the average rate of 76%, suggesting that they are subject to more intense competitive pressure.
Acknowledgements
We are grateful to seminar participants at Cambridge, and to Mark Fagan and Mike Scherer for useful comments.
Notes
1. In Fama and French's sample, financial and utility companies are not considered, and moreover, companies with less than $10 million in assets or $5 million in book equity are excluded as influential observations. In our sample, all listed companies (except those from financial sector) subject to data availability are included.
2. Fama and French found that size (log of total assets) and capital intensity (the ratio of depreciation to total assets) were statistically insignificant in their US sample. In addition to the explanatory variables eventually included in our model, current ratio (current assets to current liability), labour intensity (number of employees to net sales) and exports dummy were also considered in the first instance, but excluded due to lack of significance.
3. For the most part, state-owned shares were non-tradable during the sample period, so there would be some overlap between the dummies: D_SOE and D_TV.
4. This is based on the industry classification 2001 from the Chinese Security Regulation Commission (CSRC); a more specific classification than the 1999 one, with 14 alphabet-level industries.
5. Special treatment companies are those which have failed to comply with regulations or have suffered negative net incomes for two consecutive years. Particular transfer companies are those which have made losses for three consecutive years. Financial companies are excluded from the sample because their regulation and patronage that they are subject to is likely to determine the behaviour of profitability.
6. Chinese stock market consists of much fewer companies pre-1995, and relevant data are not fully retrievable or verifiable from extant databases.
7. This system is developed by GTA information technology Co., Ltd according to the international standards to meet the requirements of business and investment research, and it encompasses data on the China stock market and the financial statements of China's listed companies. There are several databases: Trading, Financial Statement, Trade and Quote, Mutual Fund, IPO, Event Dates and the like: some of them can be found in Wharton Research Data Services (WRDS).
8. There was no precedent of delisting in both exchanges until the end of year 2001, and since then up to 2006 about 30 companies have been delisted. This reduces the survivor bias in our sample.
9. Yearly correlation coefficients among explanatory variables in the model are available on request.
10. Results are available on request.
11. Relating to intangible assets, loan expenses, leasing, cash flow statement, debt restructuring, investment, the alteration of accounting estimation and error correction, and non-cash transaction.
