Cheng Shi, Chief Economist of ICBC International and Director of China Chief Economist Forum
ICBC International Macro Analyst Xu Jie
As early as 2005, market value management has been included in the performance evaluation indicators of state-owned controlling shareholders of listed companies. In 2022, the State-owned Assets Supervision and Administration Commission of the State Council emphasized that listed companies should pay attention to value creation and value realization at the same time, promote the simultaneous growth of their intrinsic value and market value, and form a virtuous circle to promote high-quality development to safeguard the rights and interests of shareholders. At the beginning of 2024, the SASAC further stated the importance of market value management in the performance appraisal of the heads of central enterprises, and proposed that it would further study how to incorporate market value management into the assessment system. This series of measures reflects China's continuous progress in modernizing the management of state-owned enterprises and promoting market-oriented reforms. In the practice of exploring market value management, we realize that market value management is not only to meet policy requirements, but also the internal needs of enterprises to enhance their ties with the capital market and strengthen their own governance. Market value management requires enterprises to adopt a market-oriented way of thinking and maximize their market value through systematic arrangements and technical means. Theoretically, the development of valuation theory has gone through an evolution from accounting earnings to discounted future cash flows. Based on this, we divide the factors that may have an impact on the company's value into three categories: growth factors, governance factors, and risk factors. Furthermore, combined with shareholder return on investment, the empirical results reveal three types of factors that can bring excess returns to investors: fundamental characteristics, corporate governance characteristics and specific events. Specifically, fundamental characteristics include financial indicators, such as high profitability companies tend to achieve higher alpha returns, corporate governance characteristics focus on enhancing the sustainability of a company's operations through good management, and specific events such as earnings announcements, mergers and acquisitions, and management changes that have a significant impact on stock prices. Combining these factors, we believe that the core elements of market value management include three directions: event management for risk management, brand enhancement for soft power building, and value creation for cash flow generation. Especially for state-owned enterprises, market value management not only reflects financial health, but also balances social responsibility and national strategic objectives, promotes economic stability and growth, and enhances market competitiveness.
Based on valuation theory, there are three types of factors that affect the value of a company. In the process of discussing market value management, we can start with the development path of valuation theory. Valuation theory was originally based on the basic principles of financial accounting and capital markets. In the early stages of valuation theory, accounting earnings metrics were the primary tool for assessing the value of a business. However, with the development of economic and financial theories, the discounted future cash flow method (DCF) has become the mainstream method for assessing corporate value. This approach provides a more precise picture of a business's intrinsic value by predicting and discounting its future cash flows to determine its current value, emphasizing growth factors that are primarily influenced by its future cash-generating capacity. With the passage of time, the practical application of valuation theory has become more in-depth and multi-dimensional, especially the importance of corporate governance has become increasingly prominent. A good corporate governance mechanism focuses on the supervision and control of the company's decision-making process, management behavior and shareholders' equity, which not only improves the transparency of the company's operations, but also enhances the confidence of investors and other stakeholders, which together constitute the governance factors of the company's market value. Further, the development of modern valuation theory is no longer limited to the company level, but covers a wider range of dimensions, including factors such as investor psychology and market behavior. For example, the irrational behavior of the market can lead to sharp fluctuations in the value of a company, indicating that event risk factors have a significant impact on a company's valuation. Therefore, a comprehensive consideration of growth, governance and risk factors is essential to accurately assess and manage enterprise value, making market value management more comprehensive and forward-looking.
Based on excess returns, there are three types of factors that affect the company's return on investment. The key to the success of market cap management is to provide investors with stable and substantial investment returns. This goal is achieved on the basis of understanding the various factors that affect the market value of the company, and comprehensively evaluating the growth factors, governance factors, and risk factors based on valuation theory. Further, based on the main findings of academic papers in the field of empirical asset pricing, we have identified three categories of factors that can generate alpha for investors: fundamental characteristics, corporate governance characteristics, and specific events. First, fundamental characteristics have a significant impact on a company's stock returns. By analyzing 74 academic articles from 1973 to 2016 (e.g., the influential Fama-French five-factor model, which found that high-profitability firms generate excess returns relative to low-profitability firms, i.e., the RMW factor), we have identified 10 fundamental-based characteristics (asset growth, industry-adjusted sales growth, inventory growth, book asset growth, capital expenditure growth, long-term net operating asset growth, PP&E (real estate, Plant & Equipment) plus inventory growth, consecutive quarters of higher earnings than the same period last year, sales growth minus inventory growth, standardized unexpected quarterly earnings) can bring more stable excess income. Secondly, corporate governance characteristics are also an important factor affecting investment returns. Intuitively, corporate governance characteristics have a significant impact on investment returns. High corporate governance ratings are often associated with higher book-to-value and earning-to-value ratios, suggesting that the market is valuing these companies higher. Not only that, but the rating upgrade has led to a relative decline in the forecasted earning-to-price ratio compared to the rating downgrade, which indicates an increase in valuations. The main reason is that good corporate governance can reduce systemic risk and capital costs, thereby increasing company valuations. Therefore, effective board oversight, management accountability, transparent disclosure, and reasonable stakeholder engagement are essential to reduce corporate risk and attract long-term investment. Finally, certain events, such as earnings announcements, mergers and acquisitions (M&A) announcements, and management changes, can also significantly affect a company's share price. For example, transparency and timeliness of earnings reports are critical to stock price reactions, and good information disclosure can promote positive stock price reactions. M&A activity typically boosts the target company's share price and can have a significant positive financial impact on the target company, but the impact on the acquiring company is more complex. A change in management, especially a change in CEO, often leads to a reassessment of a company's future performance. If the market believes that the new CEO will lead the company to better performance, then a positive reaction to the stock price is usually observed. Not only that, but company managers have an incentive to delay the release of bad news, which leads to a greater negative stock price reaction when the bad news is finally disclosed, and at the same time increases information asymmetry, which can lead to a loss of investor trust and a negative impact on the company's stock price and reputation.
The three core elements of market capitalization management. Market value management is a key part of corporate strategy, especially for state-owned enterprises, due to its unique ownership structure and important social functions, market value management is not only the embodiment of corporate financial health, but also an important pillar of national economic stability and growth. Combining the three factors of valuation theory and the three sources of excess returns, we summarize the core elements of market value management into three main directions: event management orientation, corporate governance orientation and value creation orientation. Through the in-depth understanding and implementation of these three core elements, SOEs can effectively manage their market capitalization and achieve long-term financial stability and growth.
First, event management focuses on identifying and mitigating specific events that may have a significant impact on a company's market capitalization, such as policy changes, restructuring of state-owned assets, and major infrastructure projects. SOEs should stabilize market expectations and reduce uncertainty and potential negative impacts through timely communication and transparent information disclosure. In addition, enhanced communication and coordination with the government is essential to ensure the alignment of operations with national policies and development objectives. Enhance communication with investors and the market during these company-specific events, thereby reducing share price volatility. While some news can generate positive returns for investors, short-term, excessively rapid stock price movements and their impact on stock prices can trigger market volatility, which in turn can hurt a company's market capitalization.
Second, corporate governance orientation aims to address agency issues, i.e., conflicts of interest between management and shareholders. According to agency theory (Jensen and Meckling, 1976), the core of corporate governance is to resolve the agency problem, i.e., the conflict of interest between management (agent) and shareholders (principal). The characteristics of corporate governance in SOEs include government intervention and management appointments and oversight mechanisms. A good corporate governance structure can increase corporate transparency, enhance investor confidence, and optimize market value. By introducing independent directors, establishing a transparent decision-making mechanism and improving the internal control system, SOEs can effectively improve the level of corporate governance.
Finally, the value creation orientation focuses on achieving sustainable growth over the long term. According to the resource base theory (Barney, 1991), a company's competitive advantage comes from its unique resources and capabilities. SOEs can leverage their strengths in access to resources, government relations, and market influence to translate into sustainable competitive advantage and shareholder value. By balancing business objectives and social responsibility, strengthening innovation capabilities, and exploring new business models and growth points, SOEs can enhance their core competitiveness and create long-term value for shareholders. For example, China's State Grid Corporation of China has achieved sustained growth in market capitalization by investing in smart grid technology and renewable energy projects to improve energy and operational efficiency, strengthen its global competitive position, and achieve sustained growth in market capitalization.
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