FINANCIAL DISTRESS RESOLUTION IN CHINA TWO CASE STUDIESAmy Kam1Augustus Asset Managers Limited David CitronCity University London - Sir John Cass Business School Gulnur MuradogluCity University London - Sir John Cass Business School

Abstract Thispaperexaminestwofinanciallydistressedcompaniesandtheirrestructuringstrategies.The existingdistressliteraturefocusesondevelopedeconomiessuchasU.S.andU.K. Thispaperisa 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,bothpre-andpost-distress,tounderstandthenatureofthefirmsdifficulties.Itthen examines the series of complex restructuring procedures each firm initiated and uses an event studyapproachtoevaluatethestockmarketsreactiontothesestrategies.Weprovideanin-depth understandingofthespecialfeaturesoftheChinesesituation,suchastheroleofgovernmentand othermorecommerciallydrivenshareholders;thesubsequentimportanceofsocialpolicyissues; the protracted and complex nature of the restructurings; and the frequent use of mergers, share transfers,assetswapsand assetsales. Theanalysisprovidesnewhypothesesforfurtherempirical study on a large-scale basis.

JEL classifications: P27, G34, L10, G33.

Keywords: Distress, Restructuring, Emerging Markets, Case Studies.

1 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.Page 11. INTRODUCTIONThis paper examines two financiallydistressed companies in China. It discusses details of their

motivations, the distress resolution strategies they employed and the valuation effects of their restructuringannouncements. Both companies chooseacombination ofrestructuringstrategies for recovery prior to and during distress. Financial distress and related recovery attempts are complex processesbytheirverynature. ByexaminingtworepresentativeChinesecasesindetail, 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

nameafew,Asquithetal(1994),Franksetal.(1996),FranksandSussman(2000),Westonetal. (2001), Kahl (2001), Franks and Sanzhar (2003). However there are very limited studies in the emergingmarketcontext. InChina,wherebankruptcylawisinitsinfancyandwherethestateis stillheavilyinvolvedasashareholder,theprocessofdistressedcompanyrestructuringislikelyto 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 developinglegalandregulatoryframeworks.Casestudymethodologyhasbeenwidelyemployed in finance research literature (Ruback 1983, DeAngelo et al. 2002, Baldwin and Mason 1983). Weadoptthismethodologyasitallowsustoexplorethelesswell-knownfeaturesofthedistress 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 operatinginagrowingandliberalisedindustryconsistingof60listedfirms.Thesecond,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

Page 2which 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 governmentindistressresolution.Finallytheyprovideaninformation-richcontexttounderstand 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 theexistingliteratureshows, firms sufferingfrom performancedeclinemaychooseavariety

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 managerialchanges.TheserestructuringstrategieshavebeenstudiedextensivelyintheU.S.and U.K.frameworks,andinotherdevelopedeconomiessuchasGermany,JapanandFrance(seefor example Gilson et al 1990, Clark & Ofek 1994, Asquith et al 1994, Franks & Sussman 2000, Franks &Sanzhar2003, Lai &Sudarsanam 1997, Furtado &Rozeff1987, 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; managerialrestructuring(changesofboardmembers,CEOsandgeneralmanagers);operational restructuring; and, to a small extent, debt restructuring. There are, however, a number of key featuresinthesecasesthatsignificantlydifferentiatethemfromrestructuringprocessesobserved indevelopedeconomies. Firstly,theprocessishighlycomplexandlong-drawnout.Secondly,the (non-tradable) shares and underlying assets of the distressed firm are sometimes transferred to otherentitieswithoutpaymentbeingmadeinreturn. Inadditionsocialconsiderationsplayarole, 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. Relatedtothislastpoint,equityrestructuringsuch asspin-offs,equitycarve-outs,trackingstock, 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).

Page 3Thepaperisorganizedas follows. Section2discussestheinstitutionalfeaturesofChina;section3 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 BACKGROUNDChinaisthemostimportantemergingmarketandisintheprocessoffinancialliberalisationfrom a closed economyto 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 lendingDue 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

governmentinterventioninbanklendingpriorto1994. Suchgovernmentinterventioncouldtake 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 dramaticallytransformed the structure of its corporate ownership. In particular, Chinas share issue privatisation (SIP) of SOEs was a catalystforthedevelopmentofitstwostockexchanges -ShanghaiSecuritiesExchange(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

2 Thecost/incomeratioofmainlandChinesebanksisamongthehighestinthe world,averagingcloseto80%,versus 35-45% in Asia and 40-55% internationally (Bank of China International 2002).Page 4capitalisation 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 inordertoallowforcontinuedstatecontroloftheselistedfirms. Inotherwords,oneofthemain

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

governmenthaskeeninterestandcriticalroleintheprocessandissuesofChinastransitionfrom 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 popularityof the equitymarket 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 stockexchangesimposestrictlistingrequirementsoncompanysizeandprofitability.Inaddition they impose even stricter rules on firms wishing to issue further equity, as a result of which it is verydifficulteven forprofitablefirmstoissueadditionalequity, letalonethe distressedones. In addition, according to the Company Law (Article 157 & 158), firms which have been making lossesfortwoconsecutiveyearsarecategorizedasspecialtreatment(ST)andarelimitedto5% share-price movements up or down daily; whereas firms that have been making losses for three

3 Strictlyspeaking,anSOEisa whollyState-OwnedEnterprise(100%). Hereweextendthedefinitiontoincludeall state-controlled enterprises (i.e. the state holds less than 100% shares) as SOEs. Byconstruct, 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. Inaddition,ifanSOEhasover50%state-ownedshares, weconsideritundertheabsolutecontrolofthe 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).Page 5consecutive 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,failingwhichtheyarede-listedfromtheStockExchange. Thisfeatureistakeninto consideration when designing our event study methodology.

2.3 Bankruptcy lawChinese Bankruptcy Law was initially promulgated to restructure or liquidate insolvent SOEs. As China began to move towards a more market driven economy additional bankruptcy4 legislationwasenacted. Similartomanyothercountries,whenacompanyisindistress,thereare two possible routes for distress resolution: 1. Private workouts; 2. Bankruptcy process during whichthecompanymayberestructuredundercourtsupervisionorliquidated. 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 METHODOLOGY3.1 The case companiesThetwodistressedcases wereselectedfromthe100companiesthatconstitutethefullpopulation 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 engagedinallthemajorrestructuringcategories,i.e.asset,operational,managerialandfinancial..

4 ThetermbankruptcyfollowstheUSdefinitionandreferstothecorporatebankruptcyprocessofcourtsupervised restructuring or liquidation, and is used interchangeably with insolvency in this study.5 AspointedoutbyGeorgeNast,principalconsultantatMcKinsey&CoChina,inacommunicationwiththeauthors, 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)).Page 6Dataforthetwo casesoperatingperformanceand capitalstructurearecollectedfromThomson

Financial Analytics Database.Industry performance controls, capital structure, and size comparisons arealso collected from this database bymatching thesample firmsprincipal four-digitcodewithotherpublicfirmswiththesameprincipalSICcodeforthesameyear. Shandong JintaiandSichuanJointWITsaccounts-basedperformancesummariesarepresentedinTable1 and 3, respectively.

Thetwo distressed companiesrestructuring announcements areobtained from thetwo Chinese stock exchanges official websites. Appendix 1 presents the CSRC official format of

announcementrequirementforlistedcompanies(thishasbeentranslatedbyoneoftheauthors). Details of the two companies restructuring related announcements6 are presented

chronologicallyinAppendix 2and3respectively. Furtherdataforthecaseanalysesareobtained 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 announcementsIn 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. Weselectaneutralperiodtoestimatethemarketmodel. IntheShandongJintaicase,the company became distressed in 2002 and the first restructuring related announcement is on the 17th ofDecember2001; weusetheestimationperiodasthefirst95days7 sincelisting(23/07/01 30/11/01).

6 Restructuring related announcements made in a multiple announcement together with other news are excluded. 7 We also repeat all analysis excluding the first 5 days of listing in the Shandong Jintai case and results do not change.Page 7

In the Sichuan Joint-WIT case, since the company became distressed in Year 2001 and the first restructuringrelated announcement was madeon 30th December2000, wedefinethe estimation period as 21/03/2000-25/12/2000. There are 200 daily observations in this estimation period Abnormalreturns(ARjt)forcompanyjattimetarecalculatedasthedifferencebetweenthedaily returns and their expected values (i.e the respective market returns), and related Cumulative Abnormal Returns (CAR) are calculated as follows:

ARjt Rjt Rmt(1)

CARj ARjt(2) tTPCARs 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 S(AR) N(0,1),(6)

where S(AR)

tEP(t T s 2tEPt )2 T s 1

(7)

jtCARTP :t S(CAR) N(0,1),(8)

whereS(CAR)

S(AR)

T s 1

(9)

4. CASE STUDIES4.1 CASE 1: SHANDONG JINTAI GROUPShandong Jintai (Jintai) was formerly a state owned enterprise and was restructured to be a shareholdingcompanyin1989. Thegroup'sprincipalactivitiesaretheresearch,manufactureand sale of chemical raw material medicines, Chinese and Western medicinal preparations and biological medicines. Other activities include manufacturing and marketing of biologicalPage 8products,medicalintermediatesandmedicalapparatus,developingandtransferringtechnologies

and providing technical services.

Thepharmaceuticalindustryisahigh growthindustryinChina. Asat2003,therewereatotalof 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%from2001to2002,withRMB94.55bnoutputin2002. Inaddition,aswecanseeinTable 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 performanceAsshowninTable1,2002wasthefirst yearofJintaisdistressasmeasured byourinterestcover

indicator,withEBITDA/interestratiomassivelynegativeat-9.83%.Jintaisinterestcoverhadin factunderperformedtheindustrymedianineachofthetwoprioryears,thoughnottoaworrying extent, so that the accounts are showing a sharp and decisive decline into distress in 2002.

Insert Table 1 hereRegarding 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 industrymedian in 1999, this ratio fell to 54%in 2000 and furtherto 43%in 2001, the yearprior to distress. Bytheend of 2002 Jintais assets were only27%oftheindustrymedian 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 performanceasindicatedbytheaccountstookplacein2002,withgrossmarginfallingfrom53%

Page 9of 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.

Thepooroperatingperformanceofthe yearspriortodistresswasaccompaniedbysignsofweak

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 by2002 thecompanywas funded 81.1%byliabilities (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.

Thecompanyemployedanumberofrestructuringstrategiessince2002,such asoperationaland

managerial restructuring, measures which seem to have a longer term strategic nature without immediatecashflowgeneratingimplications(unlikesomeoftheU.K.distressedfirmsstudiedin 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 weuse event studyto gain an understandingofmarket reactions to thecompanys announcements, paying particular attention to restructuring related news.

4.1.2 Market reaction to the restructuring strategies of Shandong JintaiFigure 1 shows the companys raw (unadjusted) stock return, and its raw return minus the

contemporaneousreturn ontheequallyweightedSZAllA-shares Index. Appendix2listsatotal

8 According to articles published on the official stock exchange website.Page 10of 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 assetsalesandoperationalrestructuring;threetomanagerialrestructuring;andfourtonewbank loans orbank loan renewal. Event studyresults oftheseannouncements arereported in Table2.

Insert Figure 1 here Insert Appendix 2 hereJintaistarteditsapplicationforlistingin1993 and waseventuallyfloated on theShanghaiStock

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 HongJiGroup. Jintaihadadispersedshareholdingstructurewiththesecondlargestshareholder holding only 7.13%. Therefore, although Xin Hong Ji Group only bought 26.99% shares in Jintai, it becamedefacto thecontrollingshareholder. Xin HongJi Group agreed to payRMB52 million for this transaction, with RMB30 million paid as a first instalment. However before the remainingRMB22millionwaspaid,theauditorofXinHongJiGroupdiscoveredthatJintaiwas facingseverefinancialproblems(seearticlepublishedonwww.cninfo.comdatedApril152003). At the time of the transaction, there was no legal requirement for either Shandong Jintai or Xin HongJiGrouptodisclosethedetailsofthetransaction. Theabnormalshare pricemovementon the announcement of this change in control was -2.51%, though not significantlydifferent from zero.

9 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.Page 11This 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 restructuringwasannounced.ThisinvolvedShandongJintaifirstlysellingoneofitsproductlines 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 directorswereappointed (accompaniedbyanon-significant-0.56%abnormalpricechange)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 disclosedinmultiplenewsannouncements,furthermanagementchangestookplaceinFebruary 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 involvedacomplex hive-offofsignificantpartsofthebusiness.These,accordingtoJintais2002 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 subsidiariesintoanewlyformedcompanyinwhichitwouldhavea20%interest;andsecondlyit was hiving off its retail business into a new pharmacyretail company in which it would have an 80%interest,withtheremaining20%heldbythe80%shareholderinthefirstannouncement.Of particularinterestthesetransactionsprovideevidenceofadistressednon-SOEtransferringeither complete or partial control of parts of its business without receiving any consideration, cash or

Page 12otherwise, indicative that these asset transfers at times of distress are not limited exclusively to

SOEs.

Theseassetrestructurings werefollowedbyanumberofleverage-increasingannouncements.On June19 2002 Jintai announced board level approval of the decision to raise working capital financefromitsbank,andonDecember132002itannouncedassumptionofanRMB20million 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 summarisedinWestonetal(2001),empiricalstudiessuggestthatthemarketreactsfavourablyto companies when they increase leverage. However Tian (2004) documents that, for China, increasedleverageincreasesmanagemententrenchmentandperks,concludingfromthisthatdebt governance is not at work in China.

In order to examine the overall market impact of the different corporate restructuring strategies, wecalculatetheaverageabnormalreturnsandthecumulativeaverageabnormalreturnsusingthe

four different categories M&A, asset sales/operational, managerial and leverage-increasing. TheresultsarereportedinTable210. Amongthefourdebt-relatedrestructuringannouncements,

two events took place on two consecutive days. To avoid confounding effects, onlythe first one is included in the calculation of average abnormal returns and cumulative average abnormal returns. Duetothesmallnumberofeventsineach category,theaverageabnormalreturnandthe cumulative average abnormal return results in Table 2 are best treated as exploratory.

Insert Table 2 hereTable2showsthatnoneoftheaverageabnormalreturnonthedayofannouncement(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.Page 1311-daycumulativeaverageabnormalreturns(CAAR+/-5)areconsistentwithAAR0,withthemost 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 produceresults ofoppositesigns, exceptformanagerial restructuringannouncements. However neither the cumulative average abnormal returns nor the AAR0 are significant statistically.

Theeventstudyresultssuggestthatthecompanys M&Astrategyisnotperceivedbythemarket 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,wealsoobserved frequentseniormanagementdepartures,oneofwhichwasperceivedby the market strongly unfavourably. We will further analyse these results in section 5.

4.2 CASE STUDY TWO: SICHUAN JOINT-WIT MEDICALSichuanJoint-WitMedicalandPharmaceuticalIndustryCompanyLimited(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.Otheractivitiesincludedimportandexporttrade,purchaseofrawcottonandmanufacture ofchemicalfibreyarn.TheGroupsmainproducts werecottonclothandcottonyarn. Thetextile industryincludedfivelistedcompanies,allunderthecontrolofthestate. Inaddition,therewasa 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 RMB608millionin1999toRMB1.39billionin2003. Sichuanwasthesmallestlistedcompany in the industry in 1999.

4.2.1 Accounts-based performancePage 14Table 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 hereIn terms of operating performance, Sichuans EBITDA/assets ratio was similar to its industry

medianpriortodistress,butbecamenegativein2001and2002.Howeverthe1999grossmargin 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 performancewasallthewhileaccompaniedbyrapidgrowthinnumbersofemployeesfrom4350 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 highlightedabove,pointtoeconomicinefficiencies beingthemaincauseofdistressforthisSOE 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 textileSOE which supposedlyhad industry-specific managementexpertisebutinvain. ThenewSOEcontrollingshareholderwasnotabletoturnthe performancearound either. In December2002 thecompanyhad toseverelycutback 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

Page 15industry 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-WITFigure 2 shows the companys raw (unadjusted) stock return, and its raw return minus the

contemporaneous return ontheequallyweighted SHAllA-shares Index. Thirteenrestructuring

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 hereAmong 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 onlyable to carryout event studyanalysis on eight events, results of which are presented in Table 4.

Year2000wasthefirst yearthatSichuanembarkedonitsfirstmajorrestructuringstrategy.This wastheplan,announced onJanuary112000,forthecontrollingstateshareholder,ChenduAsset 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 differentfromzero,wasattheveryleastindicativeofthemarketsindifferentviewofownership remaining with the state in a transaction in which the acquirer was not required to make any

Page 16payment. 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,notcompleted. ThenonSeptember182001,thecontrollingshareholder,Chendu Asset Management announced it was to transfer 48% of its holding to another textile SOE companywhichwouldbedefactothecontrollingshareholder. ThislatterdefactoM&Awithout payment transfer was eventually approved by the central government by July 2002.

AscanbeseeninFigure2,fromearly2002toSeptember2003,thestockscumulativeabnormal 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 returnwasapositive5.26%. Thegovernmentsinvolvementinemployeeredundancymeantthat 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 theentireshareholdingoftheSOEcontrollingshareholderhad 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 cancellationofthisdeal.12 Asaresultofthecourtorder,cancellationofthesharesaleagreement

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, leavingSichuan with anet cash inflowof 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 viaasset 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.Page 17previouslybeenobstructedbythecourtorderreferredtoabove, byusingpart ofitsnewly-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 continueddeteriorationin profitability, andthestockpricecontinuedtoplungefromthefirstday 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 economicallyor 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 hereAlthoughtherewerefiveassetsalesandoperationsrestructuringrelatedannouncements,threeof 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 September152003thecompanyannouncedthecancellationoftheintendedM&Awithpayment 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 announcementrelatetothemanagerialrestructuringannouncement. Theseresultsareingeneral 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.

Page 185. DISCUSSIONThe 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 variousrestructuringmethodsemployedforrecovery. First,mergersandacquisitionsarevalue-enhancing when a payment is involved and ownership is transferred from state to non-state shareholders. HoweverM&Atransactionsbetweenstatecompaniesandwithoutpaymentbeing 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 theSOESichuan case, M&Awithoutpayment was first employed with stateshares changinghandsbetweenSOEs. Whenthistransactionfailedtoturnthecompanysperformance 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 significantlypositivemarketreactiontoSichuanJoint-WitsM&Awithpaymentannouncement, theaverageabnormalreturnforShandongJintaiwasanon-significant -0.2%.Thissuggeststhat itisthetransferofcontrol fromSOEto non-SOEthatisperceived mostpositivelybythemarket 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. Eventsentailingtheappointmentofadditionaldirectorsorgeneralmanagers wereaccompanied bypositive,althoughnotstatisticallysignificant,pricereactions. Howevertheannouncementof theresignationandreplacementofkeyappointments,includingthecompanysgeneralmanager anditschieffinancialofficer,triggeredasignificantlynegativesharepricechange. Thisnegative

Page 19result 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 announcementsendsahybridsignaltothemarket. Thus,RolandandSekkat(2000)arguethatin asocialisteconomy,duetoasymmetricinformationaboutmanagerialskills,goodmanagershave 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 significantimpactonfirm values.Suchstrategies,whichwereimplementedinboththeseChinese firms, do not have immediate cash flow-generating implications. This contrasts with the cash-generatingstrategiesobservedindevelopedeconomies(Asquithetal.1994;LaiandSudarsanam 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 demonstratingthelackofthreatfrompotentialbankruptcyorliquidation. Themanagementwas able to conduct such experiments by selling assets and using the proceeds to invest in other activities, rather than meeting overdue debt payments.

Bothcompaniesfrequentlyemployedmergersand assetsalesintheirefforttorestructure. 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 termsofimproveduseofresources. UsingU.S.data,Kahl(2001)alsoarguesthatM&Aareused in re-allocating assets to more efficient uses and that, although Chapter 11 tends to maintain inefficientfirmsalive,thesedistressedfirmsarenot toleratedforlongbythemarket. Inaddition, Weston et al. (2001) argue that divestitures perform vital economic functions by moving resourcesfromlessvaluedtohighervaluedusesandthereforecontributetotheresourcemobility essential to the effective operation of an enterprise economy.

Page 20We also observe a small number of debt related restructuring announcements in the non-SOE

Shandong Jintai case. In this case thedistressed debtorrenews existingorobtains 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 protectionintheexistingformalbankruptcyprocessinChina. Inaddition,theeventstudyresults show that the market reacts negatively to the companys announcements on renewing or increasing leverage. This is contraryto the debt governance theory advocated byJensen (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 renewexistingorobtain furtherdebt maybesignalingto themarket its poor performance.

6. CONCLUSIONSThe two case studies provide an information-rich environment to understand how Chinese distressed firms restructure and how these restructuring strategies impact shareholder wealth. Assetrestructuring,includingM&Awithandwithoutpayment,assetsales,debtandmanagerial restructuringstrategies areemployedbybothfirms. Equityrestructuringisnotobservedinthese 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 frequentlysell assets under distress. The motivation for selling assets does not seem to beassociated with enablingthefirms to meet overduedebt obligations as thereis no evidence ofsignificantdebtrepayments. Instead,itisassociatedwiththeirsevereliquidityconstraintsand withprovidingliquidityforworkingcapitalrequirementsand,intheJintaicase,formanagement 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

Page 21resolutionprocessisunwelcome. Inaddition,marketsindifferencetothenon-SOEsM&Awith

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 liberalizationandwhereformalinsolvencyproceduresareabsent.Furtherinvestigationisneeded to understand the motivations and mechanisms for distressed firms in such an environment to transfertheirsharesandassetswithoutpayment,andforthecomplexjointventurestructuresthat often result from this process. In addition, the reasons for the negative market impact of certain managerialanddebtrestructuringstrategiesneedfurtherexamination.Finallyalarger-scalestudy could test whether distressed SOE acquisitions bynon-SOEs aresystematicallyviewed as more value-enhancing than other M&A strategies.

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YangK.Y.,2002,TheProspectofRestructuringoftheLocalNon-performingStocksofShanghai,Capital Magazine, September 2002.Page 25APPENDICESAppendix 1A translation of some of , Shenzhen Stock Exchange13, effective 12th March 20021.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. 2.Transactions between related partiesa. 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.3.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. 4.Shareholders meeting notice5.The resolution of shareholders meetings6.Make external investment (including entrusting) 7.Provide guarantees for othersa.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. 8.Change the purpose of funds raised9.Unusual share price movementsa. 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.10. Clarification11. Major litigation and court order12. Receiving permission to issue additional equity 13. Change share name abbreviation14. Independent director nomination13 The Shanghai exchange has similar regulations.Page 26Appendix 2 Event calendar for Shandong JintaiThese13announcements were collectedfromtheShanghaiStockExchangesofficialwebsites: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 tradingdayfollowingtheannouncement;Column2givestherestructuringtype;Column3presentsthesummaryof the announcements; Column 4 presents the shares unadjusted day return (log return); Column 5 presents the marketsdayreturn(logreturnofShanghaiSE AIndex);Column6presentsthecompanysdailyvaluegain/lossby using the absolute difference in opening and closing prices multiply by the total number of tradable shares.Dates

Restructuring type

Announcement

Firm day return

Market day return

Daily value gain/loss (RMB mn)

17/12/01

M&A announcement

Controlling shareholder (Shandong Medical Research Centre) selling its holding of 26.99% shares to Xin Hong Ji Group.

-3.12%

-0.61%

-29.17

20/12/01

Asset sales/ investment

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)

-4.17%

-2.53%

-37.99

25/12/01

M&A news follow-up

Further announcement about the controlling shareholders transfer of its 26.99% shares.

-0.08%

+0.30%

-0.68

07/01/02

Managerial restructuring

Three directors resigned and candidates elected. GM and CFO resigned and appointed new persons.

-10.96%

-1.83%

-92.26

02/02/02

M&A follow-up

Standard follow-up announcement about the M&A on 17 Dec 01.

+3.21%

+1.70%

25.78

08/02/02

Managerial restructuring

Shareholders meeting approved adding 3 directors to the board.

+1.01%

+1.01%

8.14

04/03/02

Managerial restructuring

Elected chairman for the board, secretary of board resigned, deputy GMs appointed etc.

+4.93%

+1.62%

39.34

24/05/02

Investment/ operational restructuring

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.

-1.97%

-1.42%

-16.28

19/06/02

Increase leverage (new bank loan)

Board meeting approved the motion to borrow additional loan (working capital loan, max 2 years) from its bank - to be approved by shareholders meeting.

-2.60%

-1.09%

-19.67

Page 2727/07/02

M&A follow-up

Standard follow-up announcement about the M&A on 17 Dec 01.

+1.20%

+0.49%

9.50

13/12/02

Increase leverage (new bank loan)

Took a 1-year loan of RMB20m on 11/12/02, from Jiao Tong Bank; external guarantee provided by Wu Han Dao Bo Company.

+2.31%

+0.92%

+14.25

14/12/02

Debt related (providing guarantee)

Provided guarantee for Wu Han Dao Bo Company for a 15-months RMB24m loan; this brings the companys aggregate guarantee to RMB57.66m.

+0.87%

+0.82%

+5.43

14/08/03

Increase leverage (renew loan)

The RMB20m loan was due on 08/08/03. Two new loans weretaken from the same bank to pay back the existing loan. 1st loan is RMB10m for two years, 2nd loan isRMB10m for three years. Guarantee provided by its 3rdlargest shareholder.

-1.13%

-0.68%

-4.07

Page 28Appendix 3 Event calendar for Sichuan Joint-WITThese 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 g type

Announcement

Firm day return

Market day return

Daily value gain/loss (RMB mn)

11/01/2000

M&A without payment

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)

-6.49%

-4.17%

-21.7

30/12/2000

Operations restructuring (asset restructuring)

Restructuring two subsidiaries, using both subsidiaries' operating assets as investment in the new JV, holding 70.56% and 82.63%, respectively.

1.60%

1.40%

9.1

18/09/2001

M&A without payment

Controlling shareholder Chendu Asset Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Sichuan Municipal Government

1.16%

0.80%

5.6

18/10/2001

M&A without payment

Controlling shareholder Chendu Asset Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Finance Ministry.

-0.71%

-1.76%

-2.8

06/07/2002

M&A without payment

Controlling shareholder Chendu Asset Management Co transferred its holding of 47.7% to another SOE company (in textile) and this was approved by the Finance Ministry.

0.46%

0.88%

1.75

28/01/2003

Operational restructuring

Informed by the controlling shareholder, the municipal government will lead the company's restructuring, relocation and employee redundancy.

5.50%

0.24%

16.8

23/05/2003

M&A with payment

Company was informed that the 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.

4.83%

1.07%

13.3

Page 2928/06/2003

Managerial restructuring

According to the 2003 AR, on 27-06-2003, 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.

-1.36%

-0.77%

-3.5

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).

Share pricecapped since 20th August2003.

27/08/2003

Operations restructuring (asset restructuring)

Company sold its total assets and debts relating to textile business valued at RMB26.8bn, deducting 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.

Share pricecapped since 20th August2003.

15/09/2003

M&A cancellation

Agreement reached to cancel the M&A transaction announced on 23/05/03.

Share suspended

30/09/2003

Debt restructuring

The company's accounts payable to another textile company amounting to RMB43mn was transferred to another company.

Share suspended

22/12/2003

Restructuring follow-up

announced the relisting, company's major asset sales and purchase report and auditing on these transactions.

Share suspended

Page 30TABLESTable 1 Accounting information for Shandong Jintai 1999-2003This 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)t=-2 (Y2000)t=-1 (Y2001)t=0 (Y2002)t=+1 (Y2003)Selection criterionFirmIndustry medianFirmIndustry medianFirmIndustry medianFirmIndustry medianFirmIndustry medianInterest cover VariablesOperating performance EBITDA/asset Gross Profit Margin EBITDA/sales Sales/assetFinancial performance Interest Expense/assets Current liab/total liab Total liab/assetTotal debt/assetAccounts payable/total liab AccountsPayable/SalesLiquidityCurrent asset/current liabInvestment Capex/assetsSizeSales/employee (RMBmn) Asset/employee (RMB) EmployeesSales (RMBmn) Assets (RMBmn)Equity (RMBmn)

#N/A7.327#N/A 0.096 0.296 0.417 #N/A 0.243 0.452 0.4010.0190.013 0.8110.905 0.5000.487 0.3270.244 0.1740.149 0.1930.1441.4151.201#N/A0.038#N/A0.195 #N/A 526246.9 #N/A 1353172.7382.5608.4181.9

3.9880.073 0.296 0.191 0.3810.018 0.723 0.539 0.407 0.115 0.1631.0750.0220.206 541153.9 786 162.2 425.3187.0

7.6320.093 0.457 0.220 0.4210.012 0.915 0.421 0.223 0.132 0.1301.5640.0450.181 546587.6 1344786.8

3.2440.064 0.222 0.159 0.4010.020 0.866 0.522 0.370 0.116 0.1511.0590.0070.252 629926.5 680 171.6 428.4195.3

6.8890.078 0.418 0.213 0.3920.011 0.941 0.377 0.250 0.134 0.1291.5000.0640.229 657347.4 1456988.6

-9.830-0.373 0.120 -4.275 0.0870.038 1.000 0.811 0.540 0.220 2.0400.4260.0320.031 349653.8 90427.6 316.144.9

6.9620.079 0.378 0.195 0.4280.011 0.949 0.420 0.262 0.134 0.1291.3450.0670.285 669646.0 15401184.8

-5.0785.991-0.254 0.084 0.265 0.359 -5.832 0.180 0.044 0.5080.0500.014 0.9250.892 1.1070.433 0.6750.277 0.0150.135 0.3870.1270.2811.2440.0020.066#N/A0.340 #N/A 720334.9 #N/A 166910.5240.811391.7-31.72OtherAccounts receivables/Sales0.658 Accounts receivables (days) #N/A

0.260 0.211 0.383 0.936 172.8 82.2 305.3 349.9Page 31

Table 2 Market reactions to different types of restructuring in the Shandong Jintai caseThistablepresentstheeventstudyresults fortheannouncementsmadebyShandongJintaitoreverseitsperformance declineandfinancialdistress,aslistedinAppendix2.Usingmarket modelineventstudymethodology,wecalculate the abnormal returnonday0 (AR0), cumulative abnormal return for different widthofevent windows. Inaddition, for each restructuring type, AAR0 denotes average abnormal return on day0, 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

AR0 17/12/2001-2.51% 25/12/2001-0.38% 02/02/2002 1.51%27/07/20020.70%

CAR(0,+1) -0.85% -0.85% 0.20%-0.01%

CAR(-2,+2) 2.37% 1.99% 7.92%0.89%

CAR(-5,+5) -1.50% -0.85% 2.70%-2.98%No of events4Asset sales/operational

AAR0CAAR(0,+1) -0.17% -0.38%AR0CAR(0,+1)

CAAR(-2,+2) 3.29%CAR(-2,+2)

CAAR(-5,+5) -0.54%CAR(-5,+5)20/12/2001-1.65%24/05/2002-0.20%

0.17%1.17%2.71%0.50%-0.50%-7.80%No of events2Managerial restructuring

AAR0CAAR(0,+1) -1.10% 0.24%AR0CAR(0,+1)

CAAR(-2,+2) 3.40%CAR(-2,+2)

CAAR(-5,+5) -2.62%CAR(-5,+5)07/01/2002 08/02/200204/03/2002

-9.13%*** -0.56% 3.32%AAR0

-5.58% -0.83% 6.12%CAAR(0,+1)

-5.94% -1.41% 3.18%CAAR(-2,+2)

-3.12% 2.06% 1.30%CAAR(-5,+5)No of events3-2.91%-1.79%-1.98%-0.52%Debt restructuring

AR0 19/06/2002 -1.51% 13/12/2002 1.39% 14/08/2003 -0.45%AAR0

CAR(0,+1) -1.43% 1.44% -1.40%CAAR(0,+1)

CAR(-2,+2) 1.73% 1.97% -1.45%CAAR(-2,+2)

CAR(-5,+5) -0.21% -1.58% -1.89%CAAR(-5,+5)No of events3-0.19%-0.47%0.75%-1.23%* Significant at the 10% level ** Significant at the 5% level ***Significant at the 1% levelPage 32Table 3 Accounting information for Sichuan Joint-WIT 1999-2003This 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, investmentandsize,during1999to2003.t=-1,0,and+1denotespriorto,firstandsecondyearofcoverageshortfall,respectively. Fordetaileddiscussiononeachempirical proxy see Kam et al (2005).t=-2 (Y1999)t=-1 (Y2000)t=0 (Y2001)t=+1 (Y2002)t=+2 (Y2003)Selection criterion Interest coverVariables

FirmIndustry median 15.918 17.287

FirmIndustry median 14.481 20.600

FirmIndustry median -5.632 9.971

FirmIndustry median -13.096 8.155

FirmIndustry median 9.236 8.637Operating performance EBITDA/asset Gross Profit Margin EBITDA/sales Sales/assetFinancial performance Interest Expense/assets Current liab/total liab Total liab/assetTotal debt/assetAccounts payable/total liab AccountsPayable/SalesLiquidityCurrent asset/current liabInvestment Capex/assetsSizeSales/employee (RMBmn) Asset/employee (RMB) EmployeesSales (RMBmn) Assets (RMBmn) Equity (RMBmn)

0.117 0.118 0.192 0.6080.007 0.997 0.441 0.096 0.276 0.2011.1010.0020.058 94983.7 4350 251.2 413.2 230.9

0.133 0.187 0.199 0.7030.008 0.834 0.354 0.239 0.061 0.0362.3760.0520.109 194905.5 3680608.4

0.108 0.141 0.135 0.7970.007 0.932 0.551 0.197 0.194 0.1340.5460.0140.049 61737.0 8038 395.4 496.2 222.8

0.092 0.208 0.221 0.4180.004 0.847 0.396 0.261 0.081 0.0851.5910.1190.106 236837.4 3586786.8

-0.082 0.005 -0.101 0.8140.015 0.630 0.630 0.213 0.172 0.1330.6240.0070.037 45826.7 9847 367.3 451.3 160.4

0.077 0.184 0.176 0.4330.008 0.643 0.430 0.294 0.117 0.0941.6620.0940.116 252112.7 3722988.6

-0.078 -0.038 -0.095 0.8190.006 0.699 0.717 0.199 0.152 0.1330.3180.0160.048 58900.8 6560 316.5 386.4 104.1

0.084 0.195 0.204 0.4340.010 0.796 0.449 0.340 0.048 0.0491.0450.0690.136 303226.3 37271184.8

0.200 0.060 0.143 1.3960.022 1.000 0.256 0.026 0.092 0.0172.3270.0130.371 266163.6 709.00 263.4 188.71 114.84

0.069 0.165 0.145 0.4810.008 0.907 0.548 0.374 0.147 0.1351.1560.0700.184 348226.1 30211391.7OtherAccounts receivables/Sales0.456 Accounts receivables (days) #N/A

0.033 0.034 58.1 12.4

0.016 0.164 9.8 32.9Page 33

Table 4 Market reactions to different types of restructuring in the Sichuan Joint-WIT caseThis table presents the event study results for eight announcements made by Sichuan Joint-WIT to reverse its performancedeclineandfinancialdistress,aslistedinAppendix3.Usingmarketmodelineventstudymethodology, wecalculatetheabnormalreturnonday0(AR0),cumulative abnormalreturnfordifferent widthofevent windows. In addition, for each restructuring type, AAR0 denotes average abnormal return on day 0, CAAR+1 denotes cumulativeaverageabnormalreturnfromday0to+1;CAAR+/-2 denotescumulativeaverageabnormalreturnfrom day 2 to day +2; and CAAR+/- 5 denotes cumulative average abnormal return from day 5 to day +5.M&A with paymentAR023/05/20033.76%*

CAR(0,+1)4.21%

CAR(-2,+2)10.90%***

CAR(-5,+5)10.73%No of events1Asset sales/operational

AAR0CAAR(0,+1) 3.76%* 4.21%AR0CAR(0,+1)

CAAR(-2,+2) 10.9%***CAR(-2,+2)

CAAR(-5,+5) 10.73%CAR(-5,+5)30/12/200028/01/2003

0.20%5.26%***

-0.03%0.49%3.22%7.20%***8.77%*6.18%No of events2M&A without payment

AAR0CAAR(0,+1) 2.73% 3.58%AR0CAR(0,+1)

CAAR(-2,+2) 4.63%CAR(-2,+2)

CAAR(-5,+5) 4.70%CAR(-5,+5)11/01/2000 -2.32% 18/09/2001 0.36% 18/10/2001 1.05% 06/07/2002 -0.42%AAR0

-0.60% -1.04% 0.21% -0.78%CAAR(0,+1)

0.98% 1.04% -1.62% 1.31%CAAR(-2,+2)

-6.52% -9.24% 3.94% -1.09%CAAR(-5,+5)No of events4Managerial restructuring

-0.33%-0.20%AR0CAR(0,+1)

0.03%CAR(-2,+2)

-3.32%CAR(-5,+5)28/06/2003-0.60%AAR0

-0.28%CAAR(0,+1)

-0.90%CAAR(-2,+2)

-4.54%CAAR(-5,+5)No of events1-0.60%-0.28%-0.90%-4.54%* Significant at the 10% level ** Significant at the 5% level ***Significant at the 1% levelPage 34tTP

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