China’s WTO Accession and Long-Term Profitability of Chinese Firms

Abstract

As emerging economies integrate their markets with the rest of the world, competition-driven changes in profitability are increasingly affected by shocks of various types from the business environment. We examine the dynamics of profitability distributions under such conditions using China’s WTO accession as a natural experiment to carry out before and after comparisons. Our results suggest that after WTO accession, the long-run (ergodic) distribution of conditional profitability rates of Chinese firms has become more dispersed. Due to the large proportion of firms at the poor performance end, this suggests that the financial stability of the Chinese economy will be endangered if the business environment were to deteriorate. There is an urgent need to reduce the widening span of the distribution of profitability at the lower end by accelerating the restructuring of Chinese companies.

Key Words:

• Profitability
• Convergence
• Competition
• Volatility
• China
• WTO Accession

JEL classifications:

• M21
• P27
• P52

Notes

1. The legal status of private enterprises as an organic component of the national economy was only acknowledged by the revised Constitution in March 1999. They had earlier been barred from direct foreign trade operations and were subject to restrictions in financing.

2. Sensitivity analysis has been conducted with different assumptions on initial distribution, number of states, and higher order of transitions, but this does not change the main results reported here.

3. Earlier start years, i.e. from 1992 to 1994, make the sample too small to be representative, while later start years, i.e. 1999 and 2000, will make the pre-WTO estimate too short to be stable.

4. Special treatment companies are those that have failed to comply with regulations or have suffered negative net incomes for two consecutive years. Particular transfer companies are those that have made losses for three consecutive years. Financial and property companies are excluded from the sample because their regulation and the patronage that they are subject to are likely to determine the behaviour of profitability.

5. These are companies that are incorporated in mainland China and are listed in the mainland A-share markets. A-shares are quoted in Renminbi, and currently only mainlanders and selected foreign institutional investors are allowed to trade A-shares.

6. 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 the Wharton Research Data Services (WRDS).

7. It is interesting to note that ergodic mean profitability derived from both pre- and post-WTO periods was progressively lower for the later cohorts (i.e. cohort 1997 and 1998), which of course included newer firms who had had less time to learn and establish themselves.