There must, and will, be a big change in the approach towards China's on-going State share reforms because the experiment is not proving satisfactory, Liu Jipeng, a Beijing-based economist told China Daily.

One problem is that the pilot firms selected to experiment with the flotation of non-tradable shares are not representative enough, Liu said.

China has some 1,400 listed firms, which differ from each other greatly in performance, size, shareholder structure and share types. There should be at least one representative firm selected from each type so as to form enough guiding models for all listed firms, according to the economist.

Moreover, most pilot firms chose to compensate tradable shareholders with more shares in order to float their non-tradable shares. And at the same time, non-tradable shareholders have promised not to put their shares on the market for a certain period of time. And even when that period is over, they will sell their shares section by section in order to ease market concern over possible share price falls due to market flooding.

This is potentially dangerous and will lead to losses for the two types of shareholders, Liu said.

Tradable shareholders will try their best to get the biggest possible compensation. But when they get it, they will rush to sell their shares for fear the market will be flooded when former non-tradable shares are put on the market. This stock selling will undoubtedly lead to big price reductions, he explained.

This can be seen from the behavior of the first four pilot firms.

Machinery manufacturer Sany Heavy Industries Co Ltd paid three shares and 8 yuan (97 US cents) to its tradable shareholders for every 10 shares held.

The proposal was well received at the general shareholders' meeting, but when the compensation was offered the public traders began to dump their stock.

The company's share price then fell. Its price has fallen by about 15 percent from the beginning of the compensation period.

Other firms in the first batch of reforming firms suffered from almost the same problem.

Meanwhile, using new financial derivatives, such as warrants and options, which did not exist before as tools to solve the share structure problem, is not a good idea, Liu said.

"This will complicate the reforms and bring more market risks to investors."

The approach to solve the problem should be simple and practical, he said.

The economist also suggested setting a baseline price for non-tradable shares.

Only when the market price is above the baseline, which will be set at a high level, will non-tradable shareholders be able to put their shares on the market.

In this way, non-tradable shareholders' interests are linked to the market price, and they have to try their best to improve the company's performance by asset restructuring, governance improvements and using other methods.

Using this system both sides can benefit.

About two-thirds of China's shares are non-tradable and held by State or legal bodies, a throwback to the planned economy.

(China Daily July 26, 2005)