CHINA'S stock market has been experiencing volatility in recent months. During his stay in Shanghai for delivering Corporate Finance workshops for Manchester Global MBA students, Dr. Ning Gao from Manchester Business School pointed out that such drastic fluctuation reflected the inefficiency of the stock market's function of resource allocation. 

He said the Chinese government needed to establish an effective system to help investors assess real corporate value and encourage them to operate based on the corporate fundamentals so as to develop a stable and healthy stock market. Also, as a senior lecturer in Finance for MBA program, Dr. Gao advised individual investors that it is more important to figure out the real corporate value in the long term instead of stock index.

Q: How do you comment on the recent volatility in China's stock market?

A: Fundamentally speaking, the volatility reflects that the stock market is ineffective in capital allocation. In an effective stock market, the stock prices reflect corporate fundamentals and would not deviate too much from their real value. In this way, the market would be stable because it is based on corporate fundamentals, which are relatively stable.

Severe deviation means corporate value is seriously underestimated or overstated. In both conditions, resource allocation would be null and void, so even good companies might fail to raise money from the stock market while bad ones could in virtue of good themes instead.

In a mature stock market, the high stock index reflects high corporate value, and thus leading investors to allocate their resources into such companies. But when the price signal is invalid with stock prices deviated far from corporate value, resource allocation could not be achieved effectively.

Q: What do you think are the causes of the volatility?

A: It is obvious that performance of institutional investors is a direct reason for the recent stock market volatility.

It's a tactic understanding between institutional investors that when one or two of them began to lift or suppress stock prices, the others would do it too, resulting in excessive fluctuations in stock prices. Then private investors would also follow up. But they are always in the most unfavorable position because they do not have enough necessary information and act more slowly than institutional investors.

But I have to say, stock prices would not change so acutely even under manipulation of institutional investors if everybody knows well about the corporates and agrees on their real value.

So in essence, the real problem of China's stock market and its recent turbulence is that it lacks a perfect system enables investors to assess corporate value accurately, while investors focus more on government orientation than on corporate fundamentals.

Q: The fluctuation in the past two months has somehow aroused certain negative territory. How do you think it will influence the entire Chinese share market later?

A: It's hard to say how the Chinese market will develop later. For investors, volatility brings both opportunities and challenges. The whole market is a double-edged sword. There are profitable chances, but also risk of loss.

When some people make profits, some others must lose money in a market with fixed funds. If all of them want to win, they should expect entry of sideline cashes. But you can see that everybody in China is talking about stocks, including housewives. It means the majority of us have put our money into the market.

What about overseas investors? Although the Chinese market is now opened to them, a breakthrough they had expected for long, I believe they would be cautious at this moment after seeing the market shakeout.

Q: What is your opinion about the measures China's security regulatory commission and related departments have taken in response to the stock market troubles?

A: I think all the measures taken and policies issued can temporarily ease the volatility of the market. But they are expedient and adverse to the healthy development of stock market in the long run.

As I have mentioned, to fundamentally solve the problem, the Chinese government needs to establish a perfect corporate value assessment system. Under the current market operation rules, investors do not care much about the cash flow and capital cost of the corporates, but focus on actions taken by the government.

I think the government has done too much in wrong direction. The government should not intervene in the market directly. Instead, it should establish the assessment system and encourage investors, especially institutional investors, to focus on assessment of fundamentals and real value of the corporates. To do so, the government should also urge corporates to disclose information effectively.

China has introduced a series laws and regulations related to corporate information disclosure, but their enforcement is not satisfying yet. Problems include false information disclosure and lack of credit system with continuity. By “credit,” I'm not referring only to loan credit, but also honesty in information disclosure. By “continuity,” I mean all dishonest records should be accessible to the public for a long term, with names of companies and related people. Such records would be a strong constraint for companies and people to disclose information.

In America, both chief finance officers and chief executive officers have to sign their names on financial statements publicly released. And once they were found they had disclosed false information, they would be recorded and even placed into prison in serious conditions, which will also influence their later career path.

Q: How do you evaluate China's stock market in comparison with those of developed countries?

A: China's market is quite young with only 30 years of history, while the markets in western countries have developed in hundreds of years. But we can learn their lessons and experiences. And I believe that if we adopt effective corporate value assessment system, as well as reasonable and perfect regulation and supervision measures, the Chinese stock market will get mature in a shorter term.

Q: As a senior lecturer in corporate finance, what will you suggest your students invest in the stock market now?

A: It is wise to stay away from a market with volatility and insufficient information at present.

I would suggest them to focus on corporate fundamentals and look for potentially good companies. Then wait and buy their stocks when the prices are not high to hold them in hand for three to five years. They will find it is really profitable.

There is a saying from the Bible: For were your treasure is, there will your heart be also. If all your treasure is put in the stock market, your heart will be there too and experience the feeling of riding roller coaster everyday with the market change.

So I will recommend everybody to buy stocks with a certain sum of leisure money, which you would not use in years, for long term holding rather than short-term runs.

Q: Where is the growth point for China's stock market in the future?

A: Stock reflects the real economy. As the Chinese government is encouraging innovation, industrial upgrading and business start-up, the future growth for China's stock market also lies in innovation because the economy growth will also be activated by innovation.

The fact is that the market will keep innovating itself as well. For the regulators, it will be challenging to keep pace with the market development while ensuring effective regulations and risk control.

At current stage, it is difficult to define the absolute answer as it takes time for China Securities Regulator to develop effective measures to improve operation and risk management. Further, the most important role for government is to lead the capital market to a mechanism to reflect economy and real value of individual companies.