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 markets 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.

Corresponding author. Augustus Asset Managers Limited, Bevis Marks House, 24 Bevis Marks, EC3A 7NE.
Tel. +44 (0) 207 711 6718. Email. akam@city.ac.uk.

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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 states 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
Chinas privatisation process in the past two decades has dramatically transformed the structure
of its corporate ownership. In particular, Chinas 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

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 Chinas 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

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..

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 WITs 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 markets 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).

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

tTP

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 =

tTP
S ( AR )

(
where S ( AR) =

tEP

CARTP : t =

(6)

N (0,1),

1
t )2
T s + 2 tEP
T s +1

(7)

jt

tTP

S (CAR)

where S(CAR) =

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 industrys 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 Jintais distress as measured by our interest cover
indicator, with EBITDA/interest ratio massively negative at -9.83%. Jintais 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 Jintais assets were only 27% of the industry median although, as
will be shown below, this 2002 decline was predominantly due to the companys 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 Jintais sales base in that year. Sales in 2002
were only RMB27.6 million, 84% less than the year before, due mainly to the companys
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
Jintais 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 companys
announcements, paying particular attention to restructuring related news.

4.1.2 Market reaction to the restructuring strategies of Shandong Jintai

Figure 1 shows the companys 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

According to articles published on the official stock exchange website.

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10

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.

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 latters 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 Jintais 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 companys 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 companys 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 Groups 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 companys 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, Sichuans 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 companys 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 Sichuans 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 Sichuans 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 companys 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 companys 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 markets 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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16

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 stocks 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 companys 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 governments involvement in employee redundancy meant that
it would subsidise the companys 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 markets 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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17

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 shares 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
companys 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 stocks 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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18

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 companys 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-Wits 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 markets 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 companys general manager
and its chief financial officer, triggered a significantly negative share price change. This negative

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19

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 Jintais 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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20

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 companys 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 firms 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 markets reaction suggests that market
participants view privatisation favourably and that a continuing government role in the distress

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21

resolution process is unwelcome. In addition, markets indifference to the non-SOEs 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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22

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APPENDICES
Appendix 1
A translation of some of <<The formats of announcements by listed companies>>,
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 meetings 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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26

Appendix 2 Event calendar for Shandong Jintai

These 13 announcements were collected from the Shanghai Stock Exchanges official websites: www.cninfo.com.cn
and www.cnlist.com.cn; and according to the companys 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 shares unadjusted day return (log return); Column 5 presents the
markets day return (log return of Shanghai SE A Index); Column 6 presents the companys 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 shareholders 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

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
companys 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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28

Appendix 3 Event calendar for Sichuan Joint-WIT

These 13 restructuring announcements were collected from the Shenzhen Stock Exchanges 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 shares
unadjusted day return (log return); Column 5 presents the markets day return (log return of Shenzhen A Index);
Column 6 presents the companys 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

Page

29

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

Page

30

-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

Page

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%

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%

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%

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%

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

Page

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

Page

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%

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%***

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%

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%

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

Page

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

Page

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

Page

36

16/11/2003