Differences in Valuation Between Chinese State-owned Enterprises and Non-State-owned Enterprises: Theoretical Explanations
WEI Zhihua, LIANG Fangzhi, LI Peigong, ZHANG Jiawei
School of Economics, Xiamen University;International Business School, Hainan University; School of Accounting, Shanghai Lixin University of Accounting and Finance; School of Management, China Ocean University; China Business Working Capital Management Research Center
Summary:
Since the 20th National Congress of the Communist Party, China's financial system reform has generally centered on the idea of enhancing the role of finance in serving the real economy, emphasizing the importance of the role of financial markets in improving resource allocation efficiency. In this context, the China Securities Regulatory Commission introduced the concept of a “CST Valuation” (China-specific valuation system) in November 2022, with a key goal of promoting reasonable valuations for state-owned listed enterprises (SOEs), thereby guiding financial resources to better serve national strategic objectives. Following the introduction of the CST Valuation concept, domestic media attention has increasingly focused on the valuation of SOEs, with a general perception that SOEs are undervalued. Meanwhile, existing foreign literature often posits that SOEs command higher valuations than private firms due to advantages in policy support and financing (Beuselinck et al., 2017; Boubakri et al., 2018), which contrasts with media viewpoints. This divergence between theory and practice highlights the theoretical and practical significance of studying SOE valuations. Based on the Edwards-Bell-Ohlson (EBO) valuation model, this paper analyzes two prominent corporate valuation metrics, Price-to-Book (PB) and Price-to-Earnings (PE) ratios. According to the EBO model, the PB ratio is positively correlated with a firm's future profitability, while the PE ratio reflects the growth potential of future earnings relative to current earnings. Both metrics are negatively correlated with a firm's cost of equity. In theory, SOEs—functioning as government macro-control tools—might exhibit lower future profitability and earning growth compated to private firms due to their political roles, leading to lower valuations. At the same time, SOEs may have certain advantages, such as higher earnings quality driven by stricter supervisions, which could result in higher valuations than private firms. Thus, the valuation differences between SOEs and private firms warrant empirical investigation. Using a sample of China's A-share listed companies from 2007 to 2021, this study conducts an empirical analysis of the valuation differences between SOEs and private firms, offering theoretical explanations. The findings reveal that SOEs consistently exhibit significantly lower PB ratios but higher PE ratios than private firms. The study explains this interesting phenomenon through the EBO model and mechanism testing: the low PB ratio for SOEs is mainly driven by market expectations of lower future excess returns, while their high PE ratio is primarily attributed to their lower cost of equity. Further analysis uncovers deeper reasons for these findings: (1) insufficient R&D investment, heavier social responsibility burden, and lower dividend levels shape the market's low expectations for SOEs' future profitability; conversely, high earnings quality explains SOEs' reduced cost of equity. (2) SOEs' broader contributions to the government, supply chain, and society are not adequately reflected in the current valuation system. Heterogeneity analysis shows that (1) local SOEs exhibit more pronounced low PB ratios, while central SOEs exhibit more prominent high PE ratios; (2) partial state ownership has a more positive impact on company valuations than full state control. This paper offers the following key contributions and innovations: First, it sheds light on the valuation characteristics of Chinese SOEs, addressing both academic and practical concerns. In particular, the study reveals a unique “low PB and high PE” profile of Chinese SOEs, offering theoretical insights that bridging the gap between theoretical predictions and real-world observations. Second, it uncovers the underlying theoretical logic and deeper causes of valuation differences between SOEs and private firms, providing valuable insights for the sustainable development of SOEs and the CST Valuation framework. Specifically, by applying the EBO model to explain SOE valuations in the Chinese context, this paper deepens the understanding of SOE valuation dynamics while extending the EBO model's application. Third, from the perspectives of government, supply chain, and social responsibility, it explores additional factors influencing SOE valuations. This broader stakeholder perspective contributes to the theoretical development of CST Valuation by emphasizing the importance of considering SOEs' contributions to various stakeholders, thus calling for greater government and market recognition of these contributions.
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