Corporate distress in an emerging market : the case of China
This thesis is one of the first studies to empirically examine the nature and source of financial distress, and the valuation effect of distressed companies' restructuring announcements, in an emerging market context. By describing and comparing the Chinese bankruptcy code with those of seven other countries, I find that the government's political interests and intervention, aggravated by the country's weak enforcement mechanism, result in the formal procedures rarely being used in practice. Consequently, the threat of bankruptcy is weakened and creditor protection is limited. These issues are confirmed by my empirical analysis. My empirical studies are separated into two distinct themes: China as a whole compared with what is documented in the literature; and within China state owned enterprises (SOE) versus non-SOE. Firstly, I analyse operating and financial performance and operating efficiency for 100 firms that became distressed between 1999 and 2003. I find that during the first year of distress, the main source of distress is economic, not financial. In addition, for a significant minority of firms, financial factor plays a greater role in causing cash flow shortfall prior to the onset of distress. For this reason, I believe that due to the lack of timely restructuring mechanism, financial distress leads to economic distress. My SOE versus non-SOE results suggest that "soft budget constraints" are widespread among SOEs. However, such lending bias towards SOEs does not save these SOEs from being distressed. The deliberate channeling of funds to inefficient uses results in the distortion of capital allocation. Secondly, I investigate the valuation effect of restructuring announcements made by 100 firms. Comparing to the literature, I find that asset restructuring including mergers and acquisitions (M&A) and asset sales are more frequently employed. It is the most popular strategy in my sample. In the light of difficulties in officially liquidating economically unviable firms in the Chinese context, mergers and asset sales are perhaps a market selfcorrection mechanism to ensure asset mobility, which is essential for the effective operation of an enterprise economy. Consistent with the general M&A literature, M&A creates value for the target firm shareholders. In addition, asset sales are not perceived positively by the market. A potential explanation is that the lack of bankruptcy threat in China minimises the potential benefit of avoiding bankruptcy costs which shareholders otherwise have to bear. In my SOE versus non-SOE study, M&A with payment strategy is effective only for the non-SOE firms. On the contrary, the government's attempt to revamp SOE performance by transferring the controlling ownership, either with or without payment, is not seen as effective by the market. My results also suggest that debt governance is not at work among SOEs and this affects the effectiveness of debt related restructuring. The fundamental conclusion is that government ownership has an adverse impact on the distress-resolution process as it distorts resource allocation, management incentives and investment decisions. An effective bankruptcy regime should be more independent from politically motivated government intervention.