We study share issue privatization in China that took the form of the split share structure reform. Prior to the reform, domestic A-shares are divided into tradable and non-tradable shares with identical cash flow and voting rights. Under the reform, non-tradable share holders negotiate a compensation plan with tradable share holders in order to make their shares tradable. We develop a general equilibrium model to help understand the determinants of compensation and the distribution of gains in the process of privatization. One key ingredient of our model is that we account for improved risk sharing among the holders of non-tradable and tradable shares post the reform. Our model predicts that the size of the compensation is decreasing in firm performance, contrary to the prediction based on conventional wisdom that ignores improved risk sharing due to the reform. Our empirical results using data from the reform are broadly consistent with our model's prediction.
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