When is the Client King? Evidence from Affiliated-Analyst Recommendations in China’s Split-Share Reform*
Kam C. Chan
Gordon Ford College of Business
Western Kentucky University
johnny.chan@wku.edu
Xuanyu Jiang
School of Accountancy
Central University of Finance and Economics
jiangxuanyu@163.com
Donghui Wu
School of Accountancy
The Chinese University of Hong Kong
donghui.wu@cuhk.edu.hk
Nianhang Xu†
School of Business
Renmin University of China
nhxu@ruc.edu.cn
Hong Zeng
School of Economics and Business Administration
China’s split-share reform of 2005 (the Reform) converts the previously restricted shares held by
founding shareholders to shares tradable on the open market. Against this backdrop, we study
how underwriter-affiliated analysts and firms’ large shareholders interact in the event of the
latter’s sales of restricted shares. We document that recommendations made by affiliated analysts
are significantly more optimistic when firms’ large shareholders plan to sell their restricted
shares. This optimism, however, is associated with negative post-sale stock returns, suggesting
large shareholders profit from share sales. Furthermore, large shareholders sell more restricted
shares through the affiliated brokerages for which analysts have issued more optimistic
recommendations and firms under their control are more likely to appoint such brokerages as
lead underwriters when they refinance in the future. The affiliated analysts also conduct more
site visits to the firms after the share sales, thereby improving their earnings-forecast accuracy.
Our analysis shows how conflicts of interest by financial intermediaries arise following the
Reform and lead to large shareholders’ extraction of rents from public investors.