A Re-Examination of China's Share Issue Privatization : Does it Not Improve SOE Profitability?

Previous studies (e.g., Sun and Tong, 2003; Wang et al., 2004) show that Share Issue Privatization (SIP) in China did not improve the profitability of State-owned Enterprises (SOEs). This is puzzling given that SIP improves firm profitability almost around the world and China's economic reform is widely recognized as a success. We argue that these studies did not consider the mean reversion nature of corporate profitability. In China, only SOEs with the highest profitability are chosen to privatize. After SIP, the high profitability reverses to the average level so that SIP firms will have negative profitability changes. We design a matched sample method to deal with the mean reversion problem. For a sample of 149 SIP firms, we select matching firms from a large sample of non-SIP SOEs, according to the pre-SIP firm size and profitability. We find that SIP substantially improves firms' profitability relative to the matching firms. Our results are consistent with the theory and carry important policy implication for the China's reform of SOEs